The potential built‐in supply effect from margin trading in the Chinese stock market

Abstract

Utilizing a unique daily data set, we examine how the covering of margin positions affects earnings announcement returns in the Chinese stock market dominated by retail traders. Unlike previous research on forced covering during price crashes, we propose that margin interest acts as a builtin supply and find that intensive covering of margin positions pushes down stock prices during earnings announcements of extreme good news. The release of built-in supply leads to stronger post-earnings-announcement drift (PEAD) after good news compared with that after bad news, consistent with investors' tendency to realize profits after a gain under the disposition effect.

Investor attention and the use of leverage

“…They find that leverage restriction results in a smaller disposition effect, which is the behavioral bias of holding onto losing investments for too long and selling winning investments too quickly, and in improved market timing. Consistent with the disposition effect, Li et al (2022) document strong downward pressure on stock prices after good news due to intensive margin-covering trades of retail investors in China. Barber et al (2020), in turn, find that investors who use margin debt are more overconfident, leading to more speculation and poorer investment decisions.…”

“…Consistent with the disposition effect, Li et al. (2022) document strong downward pressure on stock prices after good news due to intensive margin‐covering trades of retail investors in China. Barber et al.…”