Derivatives Leverage is a Double-Edged Sword

88 Pages Posted: 28 May 2021 Last revised: 20 Sep 2021

See all articles by Avanidhar Subrahmanyam

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University

Jingyuan Wang

Beihang University (BUAA)

Xuewei Yang

Nanjing University - School of Management and Engineering; Nanjing University - Institute of New Finance

Date Written: May 28, 2021

Abstract

Proprietary futures brokerage data allow us to analyze how the embedded leverage in derivatives affects portfolio returns and volatility across traders. Performance is persistent: Some skilled traders earn supernormal profits and some unskilled ones reliably underperform, in and out of sample. Implicit derivatives leverage enhances the performance of the former but has the reverse effect on the latter. Institutions are neither particularly skilled or unskilled, and do not benefit or suffer from leverage. Unskilled investors' levered positions amplify losses stemming from gambling proclivity, and margin calls account for the bulk of the underperformance. Skilled benefit from derivatives leverage via {\it de facto} market making and arbitraging the spot-futures basis; these traders on average earn a 19.3 bps daily return per leverage unit.

Keywords: Leverage, Futures, Margin call, Smart investors, Trading performance

JEL Classification: D03, D81, G02, G12, G23

Suggested Citation

Subrahmanyam, Avanidhar and Tang, Ke and Wang, Jingyuan and Yang, Xuewei, Derivatives Leverage is a Double-Edged Sword (May 28, 2021). Available at SSRN: https://ssrn.com/abstract=3855181 or http://dx.doi.org/10.2139/ssrn.3855181

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

Jingyuan Wang

Beihang University (BUAA) ( email )

37 Xue Yuan Road
Beijing 100083
China

Xuewei Yang (Contact Author)

Nanjing University - School of Management and Engineering ( email )

22 Hankou Road, Gulou District
Nanjing, Jiangsu 210093
China

Nanjing University - Institute of New Finance ( email )

Nanjing, Jiangsu 210093
China

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