Skip to main content Accessibility help
×
Home
Hostname: page-component-cf9d5c678-7bjf6 Total loading time: 0.451 Render date: 2021-07-27T20:47:59.661Z Has data issue: true Feature Flags: { "shouldUseShareProductTool": true, "shouldUseHypothesis": true, "isUnsiloEnabled": true, "metricsAbstractViews": false, "figures": true, "newCiteModal": false, "newCitedByModal": true, "newEcommerce": true, "newUsageEvents": true }

Deleveraging Risk

Published online by Cambridge University Press:  12 December 2017

Abstract

Deleveraging risk is the risk attributable to investing in a security held by levered investors. When there is an aggregate negative shock to the availability of funding capital, securities with a greater presence of levered investors experience extreme return realizations as these investors unwind their positions. Using data on equity loans as a proxy for the degree of levered positions in a given stock, we find robust evidence of deleveraging risk. Stocks with a high degree of short selling experience large positive returns and a decrease in short selling around periods of funding capital scarcity.

Type
Research Article
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Itzhak Ben-David, Hendrik Bessembinder (the editor), Ekkehart Boehmer (the referee), Markus Brunnermeier, Lauren Cohen, Kent Daniel, Peter Feldhütter, Marcelo Fernandes, Francisco Gomes, Jeremy Graveline, Ronen Israel, Lasse Pedersen, Tapio Pekkala, Ludovic Phalippou, Raghu Rau, Adam Reed, Ruy Ribeiro, Jason Sturgess, Avanidhar Subrahmanyam, and seminar participants at Fundação Getulio Vargas (SP), PUC-RJ, Fundação Getulio Vargas (RJ), the University of Warwick, the 2013 Asset Pricing Retreat, the 2013 Brazilian Finance Society meeting, the 2013 European Finance Association Meetings, the 2014 American Finance Association Meetings, the 2015 Cambridge–Princeton Workshop, the 2014 Hedge Fund Research Conference, the 2013 Inquire UK conference, the 2014 Inquire Europe–UK Spring Seminar, and the 2015 Consortium on Research in Hedge Funds, Trading Strategies & Related Topics for helpful comments and discussions. We gratefully acknowledge the support provided by Inquire Europe and the Cambridge Endowment for Research in Finance (CERF). We thank Andrew Ang for sharing his data on hedge fund leverage and Mark Mitchell for the convertible bond spread data.

References

Acharya, V., and Pedersen, L.. “Asset Pricing with Liquidity Risk.” Journal of Financial Economics, 77 (2005), 375410.CrossRefGoogle Scholar
Aitken, M. J.; Frino, A.; McCorry, M. S.; and Swan, P.. “Short Sales Are Almost Instantaneously Bad News: Evidence from the Australian Stock Exchange.” Journal of Finance, 53 (1998), 22052223.CrossRefGoogle Scholar
Amihud, Y.Illiquidity and Stock Returns: Cross Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 3156.CrossRefGoogle Scholar
Ang, A.; Gorovyy, S.; and van Inwegen, G. B.. “Hedge Fund Leverage.” Journal of Financial Economics, 102 (2011), 102126.CrossRefGoogle Scholar
Arora, N.; Gandhi, P.; and Longstaff, F. A.. “Counterparty Credit Risk and the Credit Default Swap Market.” Journal of Financial Economics, 103 (2012), 280293.CrossRefGoogle Scholar
Asparouhova, E.; Bessembinder, H.; and Kalcheva, I.. “Noisy Prices and Inference Regarding Returns.” Journal of Finance, 68 (2013), 665714.CrossRefGoogle Scholar
Asquith, P.; Pathak, P. A.; and Ritter, J. R.. “Short Interest, Institutional Ownership and Stock Returns.” Journal of Financial Economics, 78 (2005), 243276.CrossRefGoogle Scholar
Barroso, P., and Santa-Clara, P.. “Momentum Has Its Moments.” Journal of Financial Economics, 116 (2016), 111120.CrossRefGoogle Scholar
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 154.CrossRefGoogle Scholar
Boehmer, E.; Jones, C. M.; and Zhang, X.. “Which Shorts Are Informed?Journal of Finance, 63 (2008), 491527.CrossRefGoogle Scholar
Bollerslev, T.; Hood, B.; Huss, J.; and Pedersen, L. H.. “Risk Everywhere: Modelling and Managing Volatility.” Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2722591 (2016).Google Scholar
Brennan, M. J., and Subrahmanyam, A.. “Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns.” Journal of Financial Economics, 41 (1996), 441464.CrossRefGoogle Scholar
Brunnermeier, M., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 22012238.CrossRefGoogle Scholar
Brunnermeier, M., and Sannikov, Y.. “The I-Theory of Money.” Working Paper, Princeton University (2014).Google Scholar
Cohen, L.; Diether, K. B.; and Malloy, C. J.. “Supply and Demand Shifts in the Shorting Market.” Journal of Finance, 62 (2007), 20612096.CrossRefGoogle Scholar
Corwin, S. A., and Schultz, P.. “A Simple Way to Estimate Bid-Ask Spreads from Daily High and Low Prices.” Journal of Finance, 67 (2012), 719759.CrossRefGoogle Scholar
Coval, J. D., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479512.CrossRefGoogle Scholar
Daniel, K.; Grinblatt, M.; Titman, S.; and Wermers, R.. “Measuring Mutual Fund Performance with Characteristic-Based Benchmarks.” Journal of Finance, 52 (1997), 10351058.CrossRefGoogle Scholar
Daniel, K.; Jagannathan, R.; and Kim, S.. “Tail Risk in Momentum Strategy Returns.” Working Paper, Columbia University (2012).Google Scholar
Daniel, K. D., and Moskowitz, T. J.. “Momentum Crashes.” Journal of Financial Economics, 122 (2016), 221247.CrossRefGoogle Scholar
Dechow, P.; Hutton, A. P.; Meulbroek, L.; and Sloan, R. G.. “Short-Sellers, Fundamental Analysis, and Stock Returns.” Journal of Financial Economics, 61 (2001), 77106.CrossRefGoogle Scholar
Desai, H.; Ramesh, K.; Thiagarajan, S. R.; and Balachandran, B. V.. “An Investigation of the Informational Role of Short Interest in the Nasdaq Market.” Journal of Finance, 57 (2002), 22632287.CrossRefGoogle Scholar
Duffie, D.Presidential Address: Asset Price Dynamics with Slow Moving Capital.” Journal of Finance, 65 (2010), 12371267.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.CrossRefGoogle Scholar
Garleanu, N., and Pedersen, L. H.. “Margin-Based Asset Pricing and Deviations from the Law of One Price.” Review of Financial Studies, 24 (2011), 19802022.CrossRefGoogle Scholar
Geanakoplos, J.The Leverage Cycle.” NBER Macroeconomics Annual, 24 (2010), 166.CrossRefGoogle Scholar
Geczy, C.; Musto, D.; and Reed, A.. “Firms Are Special Too: An Analysis of the Equity Lending Market.” Journal of Financial Economics, 66 (2002), 241269.CrossRefGoogle Scholar
Gorton, G., and Metrick, A.. “Securitized Banking and the Run on Repo.” Journal of Financial Economics, 104 (2012), 425451.CrossRefGoogle Scholar
Greenwood, R., and Thesmar, D.. “Stock Price Fragility.” Journal of Financial Economics, 102 (2011), 471490.CrossRefGoogle Scholar
Gromb, D., and Vayanos, D.. “Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs.” Journal of Financial Economics, 66 (2002), 361407.CrossRefGoogle Scholar
Haldane, A. G.“Patience and Finance.” Oxford China Business Forum, Bank of England (2010).Google Scholar
Hanson, S. G., and Sunderam, A.. “The Growth and Limits of Arbitrage: Evidence from Short Interest.” Review of Financial Studies, 27 (2014), 12381286.CrossRefGoogle Scholar
Hasbrouck, J., and Seppi, D. J.. “Common Factors in Prices, Order Flows, and Liquidity.” Journal of Financial Economics, 59 (2001), 383411.CrossRefGoogle Scholar
Hu, G. X.; Pan, J.; and Wang, J.. “Noise as Information for Illiquidity.” Journal of Finance, 68 (2013), 23412382.CrossRefGoogle Scholar
Jones, C. M., and Lamont, O. A.. “Short-Sale Constraints and Stock Returns.” Journal of Financial Economics, 66 (2002), 207329.CrossRefGoogle Scholar
Khandani, A. E., and Lo, A.. “What Happened to the Quants in Aug. 2007? Evidence from Factors and Transactions Data.” Journal of Financial Markets, 14 (2011), 146.CrossRefGoogle Scholar
Korajczyk, R. A., and Sadka, R.. “Pricing the Commonality across Alternative Measures of Liquidity.” Journal of Financial Economics, 87 (2008), 4572.CrossRefGoogle Scholar
Kyle, A. S.Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 13151335.CrossRefGoogle Scholar
Kyle, A. S., and Xiong, W.. “Contagion as a Wealth Effect.” Journal of Finance, 56 (2001), 14011440.CrossRefGoogle Scholar
Mancini, L.; Ranaldo, A.; and Wrampelmeyer, J.. “Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums.” Journal of Finance, 68 (2013), 18051841.CrossRefGoogle Scholar
Mitchell, M., and Pulvino, T.. “Arbitrage Crashes and the Speed of Capital.” Journal of Financial Economics, 104 (2012), 469490.CrossRefGoogle Scholar
Moreira, A., and Muir, T.. “Volatility-Managed Portfolios.” Journal of Finance, 72 (2017), 16111644.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “Automatic Lag Selection in Covariance Matrix Estimation.” Review of Economic Studies, 61 (1994), 631653.CrossRefGoogle Scholar
Ringgenberg, M.“When Short Sellers Agree to Disagree: Short Sales, Volatility, and Heterogeneous Beliefs.” Working Paper, Washington University in St. Louis (2011).Google Scholar
Saffi, P., and Sigurdsson, K.. “Price Efficiency and Short Selling.” Review of Financial Studies, 24 (2011), 821852.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R. W.. “Liquidation Values and Debt Capacity: A Market Equilibrium Approach.” Journal of Finance, 47 (1992), 13431366.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R. W.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 3555.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R. W.. “Fire Sales in Finance and Macroeconomics.” Journal of Economic Perspectives, 25 (2011), 2948.CrossRefGoogle Scholar
White, H.A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (1980), 817838.CrossRefGoogle Scholar
Xiong, W.Convergence Trading with Wealth Effects: An Amplification Mechanism in Financial Markets.” Journal of Financial Economics, 62 (2001), 247292.CrossRefGoogle Scholar
Supplementary material: File

Richardson et al supplementary material

Richardson et al supplementary material 1

Download Richardson et al supplementary material(File)
File 136 KB
12
Cited by

Send article to Kindle

To send this article to your Kindle, first ensure no-reply@cambridge.org is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about sending to your Kindle. Find out more about sending to your Kindle.

Note you can select to send to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be sent to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

Find out more about the Kindle Personal Document Service.

Deleveraging Risk
Available formats
×

Send article to Dropbox

To send this article to your Dropbox account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Dropbox.

Deleveraging Risk
Available formats
×

Send article to Google Drive

To send this article to your Google Drive account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your <service> account. Find out more about sending content to Google Drive.

Deleveraging Risk
Available formats
×
×

Reply to: Submit a response

Please enter your response.

Your details

Please enter a valid email address.

Conflicting interests

Do you have any conflicting interests? *