Margin regulation and stock market response

Abstract

This study examines the effects of the initial margin requirements on the stock market by using daily indexes of the U.S. and some Pacific-Basin countries. Do margin requirements curb speculative activity and reduce stock market volatility? This question has recently generated considerable controversy among academics and regulators following the market crash, 1987. The recent experiences of Japan, Korea, and Taiwan with margin requirements provide significant additional information about the contemporary impact of margin policy. Chapter II deals with the related questions about the short-term relations of stock market response to margin change: (1) whether or not stock price levels change when margins change and (2) whether or not the volatility of stock return change when margins change. To investigate the relations between margin requirements and market behavior, we use the switching regression and modified Levene statistic. Bootstrap simulation is used to resolve the small-sample property. We find no consistent evidence that margin requirements affect market in the short-term. Stock price levels in Taiwan, however, seem to respond mildly to margin changes. We also show that there exists weak evidence of a liquidity effect in the relation between margin requirements and market volatility. The third chapter provides another evidence about the relation between margin requirements and stock market volatility. To find the rational measure of volatility, we consider three different proxies of volatility-rolling measure, daily volatility, and conditional measure. The multiple regression and vector auto-regressive (VAR) model are analyzed to investigate the long-term relation between margin requirements and volatility. For the short-term relation between margins and volatility, only margin decreases in Japan are found to have a significant relation. We show that the effect of margins on volatility is dominated by liquidity effect rather than speculative effect. We f...