Work

Leverage and Market Stability: The Role of Margin Rules and Price Limits

Year: 1998

Type: article

Abstract: We propose a simple model in which all agents are rational and symmetrically informed. We show that when some investors hold levered portfolios by engaging in margin borrowing, repeated rounds of trading can result in market instability -- in the sense that prices can move rationally, even in the absence of any change in fundamentals. We explore the effects of market composition and market trading rules on the stability of the market. Sufficiently large margin requirements are always associated with stability. Decreasing the margin requirements sufficiently may also ensure stability. A major result of the paper is that price limits might enhance market stability by excluding potentially destabilizing market prices. The tradeoffs involved in choosing an optimal combination of price limits and margin requirements to achieve market stability are analyzed. The possible role of specialists and price continuity rules in enhancing market stability are discussed.

Source: The Journal of Business

DOI: 10.1086/209742

Authors: Bhagwan Chowdhry, Vikram Nanda

Institutions: Indian School of Business, University of California, Los Angeles, The University of Texas at Dallas

Language: English

Topic: Financial Markets and Investment Strategies

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

OpenAlex ID: W2003585864

FWCI: 2.963

Cites: 15

Cited by: 129

Related to: 10