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Margin Trading and Comovement During Crises
[Connected stocks]

Author

Listed:
  • Bige Kahraman
  • Heather Tookes

Abstract

We exploit threshold rules governing margin trading eligibility in India to identify a causal link between margin trading and increased comovement during crises. Margin trading explains more than one-quarter of the increase return comovement that we observe during crises. To understand the mechanisms driving this result, we evaluate the relative importance of stock connections through common brokers (who provide margin financing) versus common margin traders. We find that common brokers are most important. Margin-eligible stocks that are more connected through common brokers experience larger crisis-period increases in pairwise return comovement, especially when those brokers’ clients have experienced recent portfolio losses, when their clients have outstanding margin loans in more volatile stocks, and when the brokers are large. These findings are consistent with Brunnermeier and Pedersen (2009), in which initial shocks propagate due to the tightening of margin constraints imposed by financial intermediaries.

Suggested Citation

  • Bige Kahraman & Heather Tookes, 2020. "Margin Trading and Comovement During Crises [Connected stocks]," Review of Finance, European Finance Association, vol. 24(4), pages 813-846.
    • Handle: RePEc:oup:revfin:v:24:y:2020:i:4:p:813-846.
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    File URL: http://hdl.handle.net/10.1093/rof/rfz019
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    Citations

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    Cited by:

    1. Chavas, Jean-Paul & Li, Jian & Wang, Linjie, 2024. "Option pricing revisited: The role of price volatility and dynamics," Journal of Commodity Markets, Elsevier, vol. 33(C).
    2. Richard Simmons & Paolo Dini & Nigel Culkin & Giuseppe Littera, 2021. "Crisis and the Role of Money in the Real and Financial Economies—An Innovative Approach to Monetary Stimulus," JRFM, MDPI, vol. 14(3), pages 1-28, March.
    3. Zhou, Shengjie & Ye, Qing, 2023. "Margin trading and spillover effects: Evidence from the Chinese stock markets," Emerging Markets Review, Elsevier, vol. 54(C).
    4. Chen, Xinxin & Guo, Yanhong & Song, Yingying, 2024. "Multiple time scales investor sentiment impact the stock market index fluctuation: From margin trading business perspective," The North American Journal of Economics and Finance, Elsevier, vol. 69(PA).
    5. Simmons, Richard & Dini, Paolo & Culkin, Nigel & Littera, Giuseppe, 2021. "Crisis and the role of money in the real and financial economies: an innovative approach to monetary stimulus," LSE Research Online Documents on Economics 110904, London School of Economics and Political Science, LSE Library.
    6. Kruttli, Mathias S. & Monin, Phillip J. & Watugala, Sumudu W., 2022. "The life of the counterparty: Shock propagation in hedge fund-prime broker credit networks," Journal of Financial Economics, Elsevier, vol. 146(3), pages 965-988.
    7. Chavas, Jean-Paul & Li, Jian & Wang, Linjie, 2024. "Option Pricing Revisited: The Role of Price Volatility and Dynamics," 2024 Annual Meeting, July 28-30, New Orleans, LA 343544, Agricultural and Applied Economics Association.

    More about this item

    Keywords

    Margin trading; Comovement; Crisis; Funding constraints; Leverage; Regression Discontinuity design;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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