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Margin trade, short sales and financial stability

Author

Listed:
  • Hui Ying Sng

    (Nanyang Technological University)

  • Yang Zhang

    (University of Macau)

  • Huanhuan Zheng

    (National University of Singapore)

Abstract

We model how leveraged trading activities constrained by dynamic funding availability affect financial stability. In the market, customers trade based on the fundamental value of the risky asset and make full payment for their transactions, while speculators take trading position based on margin, which is constantly adjusted by the financier, the fund provider, according to the price volatility. As a result of equilibrium price discontinuity triggered by dynamic margin requirements, trivial shocks to external supply, wealth or fundamental value can be transmitted into asset price crashes or jumps. We find that tightening margin requirements improves (mitigates) the market liquidity in the bull (bear) market, and that imposing short sale constraints helps prevent the price from falling further when the asset is sufficiently under-priced and accelerate price collapse when the asset is over-priced.

Suggested Citation

  • Hui Ying Sng & Yang Zhang & Huanhuan Zheng, 2020. "Margin trade, short sales and financial stability," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 15(3), pages 673-702, July.
    • Handle: RePEc:spr:jeicoo:v:15:y:2020:i:3:d:10.1007_s11403-019-00256-3
    DOI: 10.1007/s11403-019-00256-3
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    More about this item

    Keywords

    Margin requirement; Financial stability; Speculation; Leverage;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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