Aggregate Margin Debt and the Divergence of Price from Accounting Fundamentals
48 Pages Posted: 19 Apr 2014 Last revised: 8 Jan 2020
Date Written: March 27, 2016
We examine whether, in the aggregate, margin debt is associated with the divergence of price from accounting fundamentals. We find that investors increase their margin debt following upward price movements away from accounting fundamentals, consistent with these investors being extrapolative in aggregate. We also find evidence that margin debt appears to be linked to temporary overpricing in recent periods, as the aggregate ratio of margin debt-to- price is reliably associated with negative future returns since at least 1992. Our results are consistent with the theoretical literature which predicts extrapolative traders provide a destabilizing effect on market prices and help explain why prices diverge from accounting fundamentals.
Keywords: Margin Debt; Fundamental Analysis; Mispricing; Aggregation
JEL Classification: M40, E03
Suggested Citation: Suggested Citation