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Margin requirements, margin loans, and margin rates: practice and principles

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  • Peter Fortune

Abstract

The Board of Governors of the Federal Reserve System establishes initial margin requirements under Regulations T, U, and X. Recent margin loan increases, both in aggregate value and relative to market capitalization, have rekindled the debate about using margin requirements as an instrument to affect the prices of common stocks. Proponents of a more active margin requirement policy see the regulations as instruments for affecting the level and volatility of stock prices by influencing investors' demand for common stocks. Others believe that the announcement effects of increased margin requirements would have a stabilizing effect on the stock market and on the economy. ; This article discusses the historical background, accounting mechanics, regulation, and economic principles of margin lending. The author analyzes the data on the volume of margin loans, and he describes the history and practice of margin requirements as well the accounting framework. He assesses the extent to which initial margin requirements restrict the amount of margin lending, and he reviews the economics of margin loans, focusing on margin loans to the customers of broker-dealers. The author also develops a model of the link between the value of the put option embedded in margin loans and the margin loan rate, which he applies to determine the characteristics that should explain the high margin loan rates that typically prevail.

Suggested Citation

  • Peter Fortune, 2000. "Margin requirements, margin loans, and margin rates: practice and principles," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 19-44.
    • Handle: RePEc:fip:fedbne:y:2000:i:sep:p:19-44
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    References listed on IDEAS

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    1. Peter Fortune, 1995. "Stocks, bonds, options, futures, and portfolio insurance: a rose by any other name," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 25-46.
    2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Why Margin Requirements Made Sense in 1934
      by Mike Guttentag in The conglomerate on 2008-10-31 03:06:19

    Citations

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    Cited by:

    1. D. Matsypura & V.G. Timkovsky, 2013. "Integer programs for margining option portfolios by option spreads with more than four legs," Computational Management Science, Springer, vol. 10(1), pages 51-76, February.
    2. Alex Garivaltis, 2019. "The Laws of Motion of the Broker Call Rate in the United States," IJFS, MDPI, vol. 7(4), pages 1-23, October.
    3. Chris Florackis & Alexandros Kontonikas & Alexandros Kostakis, 2010. "Transmission of macro-liquidity shocks to liquidity-sorted stock portfolios’ returns: The role of the financial crisis," Working Papers 2011_22, Business School - Economics, University of Glasgow, revised Apr 2011.
    4. Ron Kaniel & Stathis Tompaidis & Ti Zhou, 2019. "Impact of Managerial Commitment on Risk Taking with Dynamic Fund Flows," Management Science, INFORMS, vol. 65(7), pages 3174-3195, July.
    5. Wu, Wei-Hwa, 2021. "Extendible stock loan," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    6. Bernard McSherry & Berry K. Wilson, 2020. "Margin practices and requirements during the National Banking Era: An early example of macro‐prudential regulation," Review of Financial Economics, John Wiley & Sons, vol. 38(S1), pages 210-225, March.
    7. Poledna, Sebastian & Thurner, Stefan & Farmer, J. Doyne & Geanakoplos, John, 2014. "Leverage-induced systemic risk under Basle II and other credit risk policies," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 199-212.
    8. Johannes Brumm & Michael Grill & Felix Kubler & Karl Schmedders, 2015. "Collateral Requirements And Asset Prices," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56(1), pages 1-25, February.
    9. Guanghui Huang & Weiqing Gu & Wenting Xing & Hongyu Li, 2012. "Active margin system for margin loans using cash and stock as collateral and its application in Chinese market," Papers 1202.5180, arXiv.org.
    10. Matsypura, Dmytro & Pauwels, Laurent L., 2016. "Does portfolio margining make borrowing more attractive?," International Review of Financial Analysis, Elsevier, vol. 43(C), pages 128-134.
    11. Brumm, Johannes & Grill, Michael & Kubler, Felix & Schmedders, Karl, 2015. "Margin regulation and volatility," Journal of Monetary Economics, Elsevier, vol. 75(C), pages 54-68.
    12. Guanghui Huang & Wenting Xin & Weiqing Gu, 2012. "Active margin system for margin loans and its application in Chinese market: using cash and randomly selected stock as collateral," Papers 1202.4913, arXiv.org, revised Feb 2012.
    13. Florackis, Chris & Kontonikas, Alexandros & Kostakis, Alexandros, 2014. "Stock market liquidity and macro-liquidity shocks: Evidence from the 2007–2009 financial crisis," Journal of International Money and Finance, Elsevier, vol. 44(C), pages 97-117.
    14. Eric Tymoigne, 2006. "Asset Prices, Financial Fragility, and Central Banking," Economics Working Paper Archive wp_456, Levy Economics Institute.
    15. Gallmeyer, Michael F. & Kaniel, Ron & Tompaidis, Stathis, 2006. "Tax management strategies with multiple risky assets," Journal of Financial Economics, Elsevier, vol. 80(2), pages 243-291, May.
    16. Garivaltis, Alex, 2019. "Two resolutions of the margin loan pricing puzzle," Research in Economics, Elsevier, vol. 73(2), pages 199-207.
    17. Roche, Hervé & Tompaidis, Stathis & Yang, Chunyu, 2013. "Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios," Journal of Financial Economics, Elsevier, vol. 109(3), pages 775-796.
    18. Florackis, Chris & Kostakis, Alexandros & Kontonikas, Alexandros, 2011. "Transmission of macro-liquidity shocks to liquidity-sorted stock portfolios’ returns: The role of the financial crisis," SIRE Discussion Papers 2011-31, Scottish Institute for Research in Economics (SIRE).
    19. Bruce I. Jacobs & Kenneth N. Levy & Harry M. Markowitz, 2005. "Portfolio Optimization with Factors, Scenarios, and Realistic Short Positions," Operations Research, INFORMS, vol. 53(4), pages 586-599, August.
    20. Jose Ramón Martínez Resano & Liliana Toledo Falcón, 2002. "Futuros sobre acciones: demanda e implicaciones sobre los mercados de renta variable," Working Papers 0218, Banco de España.
    21. Michael Grill & Karl Schmedders & Felix Kubler & Johannes Brumm, 2012. "Margin Requirements and Asset Prices," 2012 Meeting Papers 533, Society for Economic Dynamics.
    22. Ian Ayres & Barry J. Nalebuff, 2008. "Life-cycle Investing and Leverage: Buying Stock on Margin Can Reduce Retirement Risk," NBER Working Papers 14094, National Bureau of Economic Research, Inc.

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    Keywords

    Margins (Security trading);

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