Losing Money on the Margin
journal contributionposted on 25.02.2020, 10:23 by Daniel Ladley, Guanqing Liu, James Rockey
Margin trading is popular with retail investors around the world. To limit the scale of these investors’ potential losses, regulators impose a system of collateral requirements and margin calls. We show in this paper, however, that the collateral requirement imposed by margin calls results in negative expected returns for these traders whilst also inducing positive skew in the returns distribution. Investments in assets with symmetric returns, when traded on margin, instead offer limited losses and a small chance of a large gain, much like lottery stocks and other gambles. We demonstrate this theoretically and then show empirically, using a unique database of account data from a Chinese retail brokerage, that the realized losses of margin traders are often substantial. This leads us to question whether current regulation is appropriate.