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

Journal Of Business, Vol 71 No 2, April 1998

Posted: 21 May 1998

See all articles by Bhagwan Chowdhry

Bhagwan Chowdhry

UCLA Anderson; Indian School of Business

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

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Abstract

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 show this with a simple model in which all agents are rational and symmetrically informed. We discuss welfare implications of price stability and explore the effects of market composition and market trading rules on the stability of the market. A major result of this article is that price limits might enhance market stability by excluding potentially destabilizing market prices.

JEL Classification: G11, G12

Suggested Citation

Chowdhry, Bhagwan and Nanda, Vikram K., Leverage and Market Stability: The Role of Margin Rules and Price Limits. Journal Of Business, Vol 71 No 2, April 1998, Available at SSRN: https://ssrn.com/abstract=90890

Bhagwan Chowdhry (Contact Author)

UCLA Anderson ( email )

Los Angeles, CA 90095-1481
United States
310-825-5883 (Phone)
310-206-5455 (Fax)

HOME PAGE: http://bit.ly/bhagwanUCLA

Indian School of Business ( email )

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India

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Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

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