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Margin lending and stock market volatility

  • Peter Fortune
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    Margin loans have long been associated in the popular mind with instability in security markets, and the potential for margin lending to exacerbate the amplitude of cycles in stock prices has received considerable attention in the years since the Crash of 1929. Despite the many empirical studies of the association between margin loans or margin requirements and the volatility of stock returns, there has been no definitive answer, and the consensus among financial economists is that margin lending plays little, if any, role in shaping the probability distribution of returns on common stocks. Perhaps as a result of this, the Federal Reserve System's margin requirements have not been changed since 1974. ; This study addresses the role of margin requirements from the vantage points of economic theory and the historical record. The author reviews many of the key empirical studies of the link between margin requirements and stock prices. Economic theory suggests many reasons that the link might be weak, and this is supported by many of the empirical studies. ; The author estimates a model of the returns on common stocks in the period 1975-2001. The model includes information on the amount of margin debt outstanding. He concludes that margin loans are a statistically significant factor in the determination of stock returns, and that the effect is stronger and more reliable for the NASDAQ Composite index than for the S&P 500 index. However, the economic significance of margin debt is so low that this study is not able to support a return to the active margin policy that existed prior to 1974.

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    Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

    Volume (Year): (2001)
    Issue (Month): ()
    Pages: 3-25

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    Handle: RePEc:fip:fedbne:y:2001:p:3-25:n:4
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    1. Seguin, Paul J., 1990. "Stock volatility and margin trading," Journal of Monetary Economics, Elsevier, vol. 26(1), pages 101-121, August.
    2. Hsieh, David A & Miller, Merton H, 1990. " Margin Regulation and Stock Market Volatility," Journal of Finance, American Finance Association, vol. 45(1), pages 3-29, March.
    3. Grube, R Corwin & Joy, O Maurice & Panton, Don B, 1979. "Market Responses to Federal Reserve Changes in the Initial Margin Requirement," Journal of Finance, American Finance Association, vol. 34(3), pages 659-74, June.
    4. Gikas Hardouvelis & Steve Peristiani, 1989. "Do margin requirements matter? Evidence from U.S. and Japanese stock markets," Quarterly Review, Federal Reserve Bank of New York, issue Win, pages 16-35.
    5. Goldberg, Michael A, 1985. "The Relevance of Margin Regulations: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(4), pages 521-27, November.
    6. Paul Kofman & James T. Moser, 1993. "Stock margins and the conditional probability of price reversals," Working Paper Series, Issues in Financial Regulation 93-5, Federal Reserve Bank of Chicago.
    7. Paul Kupiec & Steven Sharpe, 1990. "Animal spirits, margin requirements, and stock price volatility," Finance and Economics Discussion Series 127, Board of Governors of the Federal Reserve System (U.S.).
    8. Eckardt, Walter L, Jr & Rogoff, Donald L, 1976. "100" Margins Revisited," Journal of Finance, American Finance Association, vol. 31(3), pages 995-1000, June.
    9. Paul H. Kupiec, 1989. "Initial margin requirements and stock returns volatility: another look," Finance and Economics Discussion Series 53, Board of Governors of the Federal Reserve System (U.S.).
    10. Largay, James A, III, 1973. "100" Margins: Combating Speculation in Individual Security Issues," Journal of Finance, American Finance Association, vol. 28(4), pages 973-86, September.
    11. Salinger, M.A., 1989. "Stock Market Margin Requirements And Volatility: Implications For Regulation Of Stock Index Futures," Papers t4, Columbia - Center for Futures Markets.
    12. Schwert, C.W., 1989. "Margin Requirements And Stock Volatility," Papers t6, Columbia - Center for Futures Markets.
    13. Gikas A. Hardouvelis, 1988. "Margin requirements and stock market volatility," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 80-89.
    14. R. Corwin Grube & O. Maurice Joy, 1988. "Some Evidence On The Efficacy Of Security Credit Regulation In The Otc Equity Market," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 11(2), pages 137-142, 06.
    15. Peter Fortune, 1999. "Are stock returns different over weekends? a jump diffusion analysis of the "weekend effect"," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 3-19.
    16. Largay, James A, III & West, Richard R, 1973. "Margin Changes and Stock Price Behavior," Journal of Political Economy, University of Chicago Press, vol. 81(2), pages 328-39, Part I, M.
    17. Grube, R. Corwin & Joy, O. Maurice & Howe, John S., 1987. "Some empirical evidence on stock returns and security credit regulation in the OTC equity market," Journal of Banking & Finance, Elsevier, vol. 11(1), pages 17-31, March.
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