IDEAS home Printed from
MyIDEAS: Login to save this article or follow this journal

Financial leverage and market volatility with diverse beliefs

  • Wen-Chung Guo
  • Frank Wang
  • Ho-Mou Wu


We develop a model of asset trading with financial leverage in an economy with a continuum of investors. The investors are assumed to have diverse and rational beliefs in the sense of being compatible with observed data. We show that an increase in leverage ratio may cause the stock price to rise in the current period because it increases the demand of optimistic investors through a leverage effect, and will result in pyramiding and depyramiding phenomena for stock prices in the subsequent period. Our results also suggest that an increase in leverage ratio also results in an increase in price volatility as well, however, under certain conditions. Price changes from pyramiding effect are also negatively associated with margin requirements. Price changes from depyramiding effect, however, may not be affected when margin calls are not triggered. Furthermore, the influences of dispersion of opinion, investment funds, and investors anticipations are also examined.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: Access to full text is restricted to subscribers.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Springer in its journal Economic Theory.

Volume (Year): 47 (2011)
Issue (Month): 2 (June)
Pages: 337-364

in new window

Handle: RePEc:spr:joecth:v:47:y:2011:i:2:p:337-364
Contact details of provider: Web page:

Order Information: Web:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Paul Kupiec & Steve Sharpe, 1989. "Animal spirits, margin requirements, and stock price volatility," Finance and Economics Discussion Series 91, Board of Governors of the Federal Reserve System (U.S.).
  2. Morris, Stephen, 1996. "Speculative Investor Behavior and Learning," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1111-33, November.
  3. Paul Kupiec, 1998. "Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since the Crash?," Journal of Financial Services Research, Springer, vol. 13(3), pages 231-255, June.
  4. repec:cep:stitep:/1984/92 is not listed on IDEAS
  5. Gikas A. Hardouvelis & Steve Peristiani, 1990. "Margin requirements, speculative trading and stock price fluctuations: the case of Japan," Research Paper 9006, Federal Reserve Bank of New York.
  6. Harrison, J Michael & Kreps, David M, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 323-36, May.
  7. Kurz, Mordecai, 1994. "On Rational Belief Equilibria," Economic Theory, Springer, vol. 4(6), pages 859-76, October.
  8. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  9. Seguin, Paul J., 1990. "Stock volatility and margin trading," Journal of Monetary Economics, Elsevier, vol. 26(1), pages 101-121, August.
  10. Daniele Coen-Pirani, 2000. "Margin Requirements and Equilibrium Asset Prices," GSIA Working Papers 2001-E5, Carnegie Mellon University, Tepper School of Business.
  11. Ho-Mou Wu & Wen-Chung Guo, 2004. "Asset price volatility and trading volume with rational beliefs," Economic Theory, Springer, vol. 23(4), pages 795-829, May.
  12. Teoh, Siew Hong & Hwang, Chuan Yang, 1991. "Nondisclosure and Adverse Disclosure as Signals of Firm Value," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 283-313.
  13. Hardouvelis, Gikas A, 1990. "Margin Requirements, Volatility, and the Transitory Components of Stock Prices," American Economic Review, American Economic Association, vol. 80(4), pages 736-62, September.
  14. Hirshleifer, Jack, 1975. "Speculation and Equilibrium: Information, Risk, and Markets," The Quarterly Journal of Economics, MIT Press, vol. 89(4), pages 519-42, November.
  15. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  16. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market liquidity and funding liquidity," LSE Research Online Documents on Economics 24478, London School of Economics and Political Science, LSE Library.
  17. Thomas Gale Moore, 1966. "Stock Market Margin Requirements," Journal of Political Economy, University of Chicago Press, vol. 74, pages 158.
  18. Hart, Oliver D & Kreps, David M, 1986. "Price Destabilizing Speculation," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 927-52, October.
  19. Kohn, Meir, 1978. "Competitive Speculation," Econometrica, Econometric Society, vol. 46(5), pages 1061-76, September.
  20. 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.
  21. Mordecai Kurz & Maurizio Motolese, 2011. "Diverse beliefs and time variability of risk premia," Economic Theory, Springer, vol. 47(2), pages 293-335, June.
  22. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  23. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
  24. Feiger, George, 1976. "What Is Speculation?," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 677-87, November.
  25. Leach, John, 1991. "Rational Speculation," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 131-44, February.
  26. Harris, Milton & Raviv, Artur, 1993. "Differences of Opinion Make a Horse Race," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 473-506.
  27. Gikas A. Hardouvelis & Panayiotis Theodossiou, 2002. "The Asymmetric Relation Between Initial Margin Requirements and Stock Market Volatility Across Bull and Bear Markets," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1525-1560.
  28. Biais, Bruno & Gollier, Christian, 1997. "Trade Credit and Credit Rationing," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 903-37.
  29. Varian, Hal R, 1985. " Divergence of Opinion in Complete Markets: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 309-17, March.
  30. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:spr:joecth:v:47:y:2011:i:2:p:337-364. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla)

or (Christopher F Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.