Leverage is a Double-Edged Sword
Journal of Finance, forthcoming
88 Pages Posted: 28 May 2021 Last revised: 24 Jun 2023
Date Written: May 28, 2021
We use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out of sample, we find that relative performance differentials across the unskilled and skilled persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by the skilled, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.
Keywords: Leverage, Futures, Margin call, Smart investors, Trading performance
JEL Classification: D03, D81, G02, G12, G23
Suggested Citation: Suggested Citation