Margin Requirements and Stock Price Volatility When Agents' Beliefs are Heterogeneous

56 Pages Posted: 12 Jun 2006 Last revised: 8 Mar 2009

See all articles by Tao Li

Tao Li

City University of Hong Kong (CityU) - Department of Economics & Finance

Date Written: August 20, 2008

Abstract

In a pure-exchange, continuous-time economy, agents, who have different subjective discount rates and heterogenous beliefs on the fundamentals, trade with each other motivated not only by the benefit of risk sharing but also by speculation. This aggressiveness in trading can increase stock price volatility under some conditions. Margin requirements limit agents' ability to speculate, thus they tend to reduce the stock price volatility in general, especially when agents' beliefs are more divergent. Furthermore, if the margins are binding, an increase in margins leads to a decrease in stock volatility in the case when the patient agent is relatively optimistic and lead to an increase in stock volatility when the patient agent is relatively pessimistic. Margin requirements also stabilize the redistribution of wealth caused by the trading (speculating) of stocks and alter the equilibrium interest rates. Some dynamic implications of margin requirements are also explored through a simulated example.

Keywords: Margin Requirements, Heterogeneous Beliefs, Stock Volatility, Leverage Effects

JEL Classification: D58, D84, E44, G10, G12, G18

Suggested Citation

Li, Tao, Margin Requirements and Stock Price Volatility When Agents' Beliefs are Heterogeneous (August 20, 2008). Available at SSRN: https://ssrn.com/abstract=907465 or http://dx.doi.org/10.2139/ssrn.907465

Tao Li (Contact Author)

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

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