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Margin Requirements and Portfolio Optimization: A Geometric Approach

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  • Sheng Guo

    ()
    (Department of Economics, Florida International University)

Abstract

Using geometric illustrations, we investigate what implications of portfolio optimization in equilibrium can be generated by the simple mean-variance framework, under margin borrowing restrictions. First, we investigate the case of uniform marginability on all risky assets. It is shown that changing from unlimited borrowing to margin borrowing shifts the market portfolio to a riskier combination, accompanied by a higher risk premium and a lower price of risk. With the linear risk-return preference, more stringent margin requirements lead to a riskier market portfolio, contrary to the conventional belief. Second, we investigate the effects of differential marginability on portfolio optimization by allowing only one of the risky assets to be pledged as collateral. It is shown that the resulting optimal portfolio is not always tilted towards holding more of the marginable asset, when the margin requirement is loosened.

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File URL: http://economics.fiu.edu/research/working-papers/2014/1406/1406.pdf
File Function: First version, 2014
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Bibliographic Info

Paper provided by Florida International University, Department of Economics in its series Working Papers with number 1406.

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Length: 26 pages
Date of creation: Apr 2014
Date of revision:
Handle: RePEc:fiu:wpaper:1406

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Keywords: portfolio optimization; margin; collateral; borrowing constraint; mean-variance; efficient frontier; asset allocation;

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