Keywords

margin constraints, asset pricing, arbitrage, investor sentiment, price efficiency

Abstract

We provide experimental evidence that relaxing margin restrictions to allow more short selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short selling is not possible, competitive pressures among arbitrageurs rapidly drive prices to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier. 2002. Journal of Financial Economics 66(2–3):341–60; 2003. Econometrica 71(1):173–204). (JEL G14, C92)

Original Publication Citation

Bhojraj, S., R. J. Bloomfield, and W. B. Tayler. 2009. Margin Trading, Overpricing, and Synchronization Risk. Review of Financial Studies 22 (5):2059-2085.

Document Type

Peer-Reviewed Article

Publication Date

2008

Publisher

Review of Financial Studies

Language

English

College

Marriott School of Business

Department

Accountancy

University Standing at Time of Publication

Full Professor

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