Margin Trading, Overpricing, and Synchronization Risk

54 Pages Posted: 24 Aug 2005

See all articles by Sanjeev Bhojraj

Sanjeev Bhojraj

Cornell University - Samuel Curtis Johnson Graduate School of Management

Robert J. Bloomfield

Cornell University - Samuel Curtis Johnson Graduate School of Management

William B. Tayler

Brigham Young University

Multiple version iconThere are 2 versions of this paper

Abstract

We provide experimental evidence that relaxing margin restrictions to allow more short-selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short-selling is not possible, competitive pressures among arbitrageurs rapidly drive them to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier 2002; 2003).

Keywords: Market Efficiency, Limits to Arbitrage, Bubbles, Experimental Economics

JEL Classification: A10, C90, C72, G10, M40, G30, G14, C92

Suggested Citation

Bhojraj, Sanjeev and Bloomfield, Robert J. and Tayler, William B., Margin Trading, Overpricing, and Synchronization Risk. Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=786008 or http://dx.doi.org/10.2139/ssrn.786008

Sanjeev Bhojraj

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Accounting
Ithaca, NY 14853
United States
607-255-4069 (Phone)
607-254-4590 (Fax)

Robert J. Bloomfield (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

450 Sage Hall
Ithaca, NY 14853
United States
607-255-9407 (Phone)
607-254-4590 (Fax)

William B. Tayler

Brigham Young University ( email )

Brigham Young University
519 TNRB
Provo, UT 84602
United States
(801) 422-5972 (Phone)
(801) 422-0621 (Fax)

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