Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since the Crash?

Abstract

This study assesses the state of the policy debate that surrounds the Federal regulation of margin requirements. A relatively comprehensive review of the literature nds no undisputed evidence that supports the hypothesis that margin requirements can be used to control stock return volatility and correspondingly little evidence that suggests that margin-related leverage is an important underlying source of \excess" volatility. The evidence does not support the hypothesis that there is a stable inverse relationship between the level of Regulation T margin requirements and stock returns volatility nor does it support the hypothesis that the leverage advantage in equity derivative products is a source of additional returns volatility in the stock market.

Margin Requirements and the Security Market Line

“…This finding has been disputed by a number of authors, including Kupiec (1989), Schwert (1989), and Hsieh and Miller (1990), who attribute the finding of Hardouvelis (1990) to flaws in the empirical tests. An extensive review by Kupiec (1997) concludes that there is no undisputed evidence that margin regulation affects stock market volatility.…”

“…Starting with Moore (1966) and Officer (1973), the nearly unanimous conclusion in the literature is that margin regulation has no impact on market volatility (see Ferris and Chance (1988), Kupiec (1989), Schwert (1989), and Hsieh and Miller (1990)). Kupiec (1997) provides an extensive review of this literature. Moore (1966) and Hsieh and Miller (1990) report that an increase in the margin requirement leads to a decrease in the amount of margin credit.…”

Index Futures and Predictability of the Underlying Stocks’ Returns: The Case of the Nikkei 225

“…However, both Bacha and Vila (1994), which employs the underlying stock index, and Chang et al (1999), which uses the underlying component stocks, find no change in price volatility in the underlying market around the SIMEX listing of the Nikkei 225 futures on September 3, 1986, while differing in the price volatility effect around the OSE listing. Similarly, Edwards (1988) and Kupiec (1998) dismiss the role played by derivative contracts in the 1987 market crash.…”

Derivatives, Volatility and Price Discovery

“…In a sense, the high level of implicit leverage transfers the informational inefficiencies of credit markets -namely adverse selection (low-quality credits drive out high-quality ones) and moral hazard (borrowers lack the proper incentives to repay) -to derivatives markets, and may thus hinder the efficient operation of the latter during times of stress. Kupiec (1997) reviews the theoretical and empirical literature relating leverage to asset-price volatility.…”