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Deleveraging Risk

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.

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Corresponding author
* Richardson, srichardson@london.edu, London Business School and AQR Capital Management; Saffi (corresponding author), psaffi@jbs.cam.ac.uk, University of Cambridge Judge Business School and CERF; and Sigurdsson, kari.sigurdsson@aqr.com, AQR Capital Management.
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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.

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