Stock market margin requirements and volatility: Implications for regulation of stock index futures

This article reexamines the evidence on the relationship between stock market margin buying and volatility, and discusses the implications for the regulation of futures markets margin requirements. Post-war data provide no evidence of a link between the initial margin requirements set by the Federal Reserve and stock market volatility. Over the entire period in which the Federal Reserve has set margin requirements (1934-present), there is a correlation between margin requirements and margin debt on the one hand and volatility on the other. However, margin debt is not primarily associated with downside volatility and margin requirements are not primarily associated with upside volatility, as would be expected if margin buying were the cause of the volatility. Thus, the experience with stock market margin requirements provides no support for regulating futures markets margins in order to curb volatility. While this evidence does not rule out the possibility that margin buying contributed to the speculative boom of the 1920s and the 1929 crash, margin debt represented a much greater fraction of the 1929 stock market than have stock market futures in the 1980s. Even taking the experience of the 1920s into account, therefore, there is still no justification for regulating futures margins in order to curb volatility.This article was prepared for the Columbia Center for the Study of Futures Markets Conference on Regulatory and Structural Reform of Stock and Futures Markets.     

Margin requirements and stock volatility

Since 1934 the Federal Reserve Board has had the power to set separate limits on the amount of credit that can be extended to purchasers of common stock. There has been much recent debate about the efficacy of these margin regulations. This article argues that the Fed has responded to increases in stock prices by raising margin requirements. The increase in prices has been associated with a decrease in volatility. There is no evidence that changes in margin requirements reduce subsequent stock return volatility. Also, trading halts have not had much effect on volatility in the past. Trading halts that were associated with banking panics were associated with high stock return volatility, but halts without bank panics were not associated with high levels of volatility.This article summarizes discussion that was presented at the Columbia Center for the Study of Futures Markets Conference on Regulatory Reform of Stock and Futures Markets, May 12, 1989.     

The Differential Impact of Federal Reserve Margin Requirements on Stock Return Volatility

This study examines the effect of changes in margin requirements on stock price volatility. We examine the possibility that the impact of margin requirements varies with a stock's degree of speculative interest. Using four alternative measures of speculative interest, we divide our sample into ten portfolios. We find no consistent evidence of a relationship between margin requirements and changes in volatility for any portfolio. The inconsistent and often contradictory results produced by these changes question its usefulness by Federal Reserve decision makers.     

An Examination of Stock Market Return Volatility During Overnight and Intraday Periods, 1964–1989

This paper examines the variance of hourly market returns during 1964–1989. Results indicate that return volatility falls from the opening hour until early afternoon and rises thereafter and is significantly greater for intraday versus overnight periods. Market variance is also shown to change significantly over time, rising after NASDAQ began in 1971, rising after trading in stock options began in 1973, falling after fixed commissions were eliminated in 1975, rising after trading in stock index futures was introduced in 1982, and falling after margin requirements for stock index futures became larger in 1988.     

Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since the Crash?

This study assesses the state of the policy debate that surrounds the federal regulation of margin requirements. A review of the literature finds no undisputed evidence that supports the hypothesis that margin requirements can be used to control stock return volatility and correspondingly little evidence that suggests that margin-related leverage is an important underlying source of excess volatility. The evidence does not support the hypothesis that there is a stable inverse relationship between the level of Regulation T margin requirements and stock returns volatility nor does it support the hypothesis that the leverage advantage in equity derivative products is a source of additional returns volatility in the stock market.     

One Market? Stocks,Futures, and Options During October 1987

We provide new evidence regarding the degree of integration among markets for stocks, futures and options prior to and during the October 1987 market crash. Where previous analyses have resulted in recommendations for the implementation of circuit breakers, the coordination of margin requirements across markets, and changes in regulatory jurisdiction, our analysis indicates that delinkage between markets during the crash was primarily caused by an antiquated mechanism for processing stock market orders. The results suggest that market integration may be better served by efficient order execution than by further restricting markets. To a large extent, the problems of mid-October can be traced to the failure of these market segments [stocks, stock index futures, and stock options] to act as one. (Report of the Presidential Task Force [Brady Report] (1988, Executive Summary, p. vi)).     

Price volatility,international market links,and their implications for regulatory policies

Conclusions The October 1987 stock market crash spawned an abundance of research papers, as scholars attempted to explain what seemed at the time, and to some extent remains, an inexplicable event.Except for the period immediately around the crash, there is only meager evidence that international linkages across markets have become tighter over time. Yet the crash was worldwide in scope, and its similarity across countries was uncanny. Just on the face, this international similarity puts doubt to such explanations as particular macroeconomic events in one country, failure of a given country's market system, or simultaneous changes in underlying fundamentals (which were quite different across countries).Assigning the origination of the crash to one country cannot be entirely ruled out, however, because of the possibility of a non-fully revealing equilibrium contagion process of the type suggested by King and Wadhwani (1988). Such a process would allow a world-wide crash to begin by a particular news event or even by a market mistake in one country. Evidence in favor of this process is that international correlations of returns increased dramatically during the crash period. However, this increase is consistent with other explanations, such as transaction costs hindering international arbitrage except during periods of high volatility.Was the crash the bursting of a bubble? Some evidence seems to support this proposition: for example, in the majority of countries, the pre-crash period displayed significant serial dependence in stock returns, dependence that was definitely not present in the post-crash period. However, further work is necessary to ascertain whether this measured serial dependence is unusual relative to what one would have expected to find, even in a perfectly random process, by choosing a sample period that happened to culminate in a random peak. Ross (1987) shows that such ex post sample period selection will induce upward bias in estimates of serial dependence. Cross-country tests failed to detect this bias, but there are several ambiguities in the tests that will have to be resolved in future work.The crash is history. What implications, if any, does it have for regulatory policy? Is there evidence that popular regulations or rules would have mitigated the crash, or that they would decrease price volatility in general? There is very little evidence in favor of the efficacity of margin requirements, price limits, or transactions taxes. Despite a large number of empirical studies, no one has provided evidence that margin requirements have an impact on volatility. There has been at least one recent paper claiming the contrary, but a careful examination of its methods have uncovered enough problems to cast those results into doubt.As for price limits, there must be a very short-term impact on measured volatility, for the measured market price at a trading halt is likely to understate the direction of movement. Yet even for daily data, the cross-country evidence is slim that price limits reduce volatility, and there is no evidence at all that they work over periods as long as a week. In other words, trading halts caused by limits seem to have no effect on true volatility.Transaction taxes are inversely but insignificantly correlated with volatility across countries, and the effect is too questionable for taxes to be used with confidence as an effective policy instrument.     

VOLATILITY FORECASTS,TRADING VOLUME,AND THE ARCH VERSUS OPTION‐IMPLIED VOLATILITY TRADE‐OFF

We investigate empirically the role of trading volume (1) in predicting the relative informativeness of volatility forecasts produced by autoregressive conditional heteroskedasticity (ARCH) models versus the volatility forecasts derived from option prices, and (2) in improving volatility forecasts produced by ARCH and option models and combinations of models. Daily and monthly data are explored. We find that if trading volume was low during period t?1 relative to the recent past, ARCH is at least as important as options for forecasting future stock market volatility. Conversely, if volume was high during period t?1 relative to the recent past, option‐implied volatility is much more important than ARCH for forecasting future volatility. Considering relative trading volume as a proxy for changes in the set of information available to investors, our findings reveal an important switching role for trading volume between a volatility forecast that reflects relatively stale information (the historical ARCH estimate) and the option‐implied forward‐looking estimate.     

Interest Rate Surprises and Stock Prices

This paper examines the impact of unexpected changes in the federal funds target on stock prices from 1988 to 2001. Measures of interest rate surprises are constructed from survey data and changes in the 3-month T-bill yield. I find that surprises associated with decreases in the target cause stock prices to rise significantly. Surprises associated with increases in the target increase stock market volatility on the announcement day, with volatility reverting to pre-surprise levels on the day after the announcement. This volatility pattern is only evident since 1994. An implication is that concerns about immediate disclosure causing persistent and heightened stock market volatility might be misplaced.     

Multivariate FIAPARCH modelling of financial markets with dynamic correlations in times of crisis

This paper applies the vector AR-DCC-FIAPARCH model to eight national stock market indices' daily returns from 1988 to 2010, taking into account the structural breaks of each time series linked to the Asian and the recent Global financial crisis. We find significant cross effects, as well as long range volatility dependence, asymmetric volatility response to positive and negative shocks, and the power of returns that best fits the volatility pattern. One of the main findings of the model analysis is the higher dynamic correlations of the stock markets after a crisis event, which means increased contagion effects between the markets. The fact that during the crisis the conditional correlations remain on a high level indicates a continuous herding behaviour during these periods of increased market volatility. Finally, during the recent Global financial crisis the correlations remain on a much higher level than during the Asian financial crisis.     

Initial margin policy and stochastic volatility in the crude oil futures market

This article examines the relationship between the volatilityof the crude oil futures market and changes in initial marginrequirements. To closely match changes in futures market volatilitywith the corresponding changes in margin requirements, we inferthe volatility of the futures market from the prices of crudeoil futures options contracts. Using a mean-reverting diffusionprocess for volatility, we show that changes in margin policydo not affect subsequent market volatility.     

融资融券能否提高交易所自律监管效率?

本文利用沪深300指数日收益率为样本,采用GARCH-M模型、EGARCH-M模型分析融资融券业务推出对我国股市波动性的影响,并以波动性为交易所自律监管效率的代理变量来进一步说明融资融券能否提高我国交易所自律监管的效率。结果表明:融资融券业务从试点推出到转为常规业务的一年半以来,我国股市的波动性有所减小,波动的杠杆效应减弱,表明融资融券能起到稳定市场的作用。同时也说明了金融创新工具推出和应用的市场化改革能够促进我国交易所自律监管功能的发挥。     

Relationship between gold and stock markets during the global financial crisis: Evidence from nonlinear causality tests

This paper investigates the nonlinear dynamic co-movements between gold returns, stock market returns and stock market volatility during the recent global financial crisis for the UK (FTSE 100), the US (S&P 500) and Japan (Nikkei 225). Initially, the bivariate dynamic relationships between i) gold returns and stock market returns and ii) gold returns and stock market volatility are tested; both of these relationships are further investigated in the multivariate nonlinear settings by including changes in the three-month LIBOR rates. In this paper correlation integrals based on the bivariate model show significant evidence of nonlinear feedback effect among the variables during the financial crisis period for all the countries understudy. Very limited evidence of significant feedback is found during the pre-crisis period. Results from the multivariate tests including changes in the LIBOR rates provide results similar to the bivariate results. These results imply that gold may not perform well as a safe haven during the financial crisis period due to the bidirectional interdependence between gold returns and, stock returns as well as stock market volatility. However, gold may be used as a hedge against stock market returns and volatility in stable financial conditions.     

Volatility dependences of stock markets with structural breaks

We develop a Vector Heterogeneous Autoregression model with Continuous Volatility and Jumps (VHARCJ) where residuals follow a flexible dynamic heterogeneous covariance structure. We employ the Bayesian data augmentation approach to match the realised volatility series based on high-frequency data from six stock markets. The structural breaks in the covariance are captured by an exogenous stochastic component that follows a three-state Markov regime-switching process. We find that the stock markets have higher volatility dependence during turmoil periods and that breakdowns in volatility dependence can be attributed to the increase in market volatilities. We also find positive correlations between the Asian stock markets, the European stock market, and the UK stock market. The US stock market has positive correlations with all other markets for most of the sample periods, indicating the leading position of US stock market in the global stock markets. In addition, the proposed three-state VHARCJ model with Dynamic Conditional Correlation (DCC) and break structure under student-t distribution has a superior density forecast performance as compared to the competing models. The forecast models with structural breaks outperform those without structural breaks based on the log predicted likelihood, the log Bayesian factor, and the root mean square loss function.     

Financial liberalization and changes in the dynamic behaviour of emerging market volatility: Evidence from four Latin American equity markets

This paper examines whether the dynamic behaviour of stock market volatility for four Latin American stock markets (Argentina, Brazil, Chile and Mexico) and a mature stock market, that of the US, has changed during the last two decades. This period corresponds to years of significant financial and economic development in these emerging economies during which several financial crises have taken place. We use weekly data for the period January 1988 to July 2006 and we conduct our analysis in two parts. First, using the estimation of a Dynamic Conditional Correlation model we find that the short-term interdependencies between the Latin America stock markets and the developed stock market strengthened during the Asian, Latin American and Russian financial crises of 1997–1998. However, after the initial period of disturbance they eventually returned to almost their initial (relatively low) levels. Second, the estimation of a SWARCH-L model reveals the existence of more than one volatility regime and we detect a significant increased volatility during the period of crisis for all the markets under examination, although the capital flows liberalization process has only caused moderate shifts in volatility.     

Asset Pricing with Dynamic Margin Constraints

This paper provides a novel theoretical analysis of how endogenous time‐varying margin requirements affect capital market equilibrium. I find that margin requirements, when there are no other market frictions, reduce the volatility and correlation of returns as well as the risk‐free rate, but increase the market price of risk, the risk premium, and the price of risky assets. Furthermore, margin requirements generate a strong cross‐sectional dispersion of stock return volatilities. The results emphasize that a general equilibrium analysis may reverse the conclusions of a partial equilibrium analysis often employed in the literature.     

SENSITIVITY OF INVESTOR REACTION TO MARKET DIRECTION AND VOLATILITY: DIVIDEND CHANGE ANNOUNCEMENTS

We examine whether investor reactions are sensitive to the recent direction or volatility of underlying market movements. We find that dividend change announcements elicit a greater change in stock price when the nature of the news (good or bad) goes against the grain of the recent market direction during volatile times. For example, announcements to lower dividends elicit a significantly greater decrease in stock price when market returns have been up and more volatile. Similarly, announcements to raise dividends tends to elicit a greater increase in stock price when market returns have been normal or down and more volatile, although this latter tendency lacks statistical significance. We suggest an explanation for these results that combines the implications of a dynamic rational expectations equilibrium model with behavioral considerations that link the responsiveness of investors to market direction and volatility.     

Race to the center: competition for the Nikkei 225 futures trade

This paper examines the impact of changes in margin requirements on returns, transaction volume, and price volatility of the Nikkei 225 futures traded on the Osaka Securities Exchange (OSE) and the Singapore International Monetary Exchange (SIMEX). An increase in margin requirement on one exchange reduces its trading volume and shifts trade to the competing exchange. Both conditional price volatility and returns are not systematically affected by changes in margin requirements. The loss of OSE's market share of the Nikkei futures trade from 1990 to 1993 is partly due to the increased transactions costs (relative to SIMEX), including the margin requirement.     

The Asymmetric Relation Between Initial Margin Requirements and Stock Market Volatility Across Bull and Bear Markets

Higher initial margin requirements are associated with lowersubsequent stock market volatility during normal and bull periods,but show no relationship during bear periods. Higher marginsare also negatively related to the conditional mean of stockreturns, apparently because they reduce systemic risk. We concludethat a prudential rule for setting margins (or other regulatoryrestrictions) is to lower them in sharply declining marketsin order to enhance liquidity and avoid a depyramiding effectin stock prices, but subsequently raise them and keep them atthe higher level in order to prevent a future pyramiding effect.     

A note on the temporal variability of Canadian financial services stock returns

We show that Financial Services stock returns in Canada are covariance nonstationary with respect to any benchmark variable and vary negatively with interest rate levels. We find that the conditional correlation between financial services stock returns and the market returns varies directly and monotonically with market volatility. This result is robust to monetary regime shifts and other sources of high volatility. These findings, combined with those of Kane and Unal (1988) for the U.S., cast considerable doubt on the constant coefficient Two-Index model and its variants, to provide reliable estimates of usual risk measures.