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Do Security Prices Rise or Fall When Margins Are Raised?

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Jean-Marc Bottazzi, Mário Páscoa and Guillermo Ramírez

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Without rehypothecation, raised margin typically decreases the price of the collateral (houses prices for mortgage, or the price of other collateral used to asset back securities). In fact, the only leverage provided is to the long side of the collateral market, who is funding collateral purchases. Reduced leverage, everything else being equal, means less buying and hence a lower collateral price. The situation is less clear, however, in the presence of rehypothecation, for example in the securities markets. Securities serve as collateral when financing their own purchase and then cash lenders manage to repledge or short sell the collateral they have accepted. That is, in these markets, self-collateralization combined with collateral reuse allow for short positions. With counterparty clearing houses (CCPs), exchanges or prime brokers both the long side and the short side need to post margin and are thus affected by variation of initial margin and haircut in futures and securities markets.

In this theory paper the authors show that since leverage is provided to both the long and the short side, the price impact of a leverage reduction can also go either way. Observing for example European sovereign crisis it is not always true that higher margin lead to a lower price reaction, on the contrary the reaction can be a sharply higher price. It does suggest that the impact of raising margin is not always to push the price of the collateral down. The authors suggest that in securities markets it depends on positioning. For this reason, as positioning changes quickly over time, one can expect the impact of margins to be more visible in short term market reactions rather than in long term trends. Raising margin could at times have had more impact on the short side. And a contributing factor market recoveries is shorts being the leveraged traders being forced to deleverage when margin is raised. In market parlance, a security market is long when the longs are leveraged and short when it is the shorts that are more leveraged instead. The authors can rigorously define a terminology that superficially seems to clash with market clearing (which requires longs and shorts to be matched). The emphasis is on where the leverage is when the haircut rises. If the short side gets to be reduced more than the long side (which happens when ‘the market is short’), then the price of the security going up, everything else being equal, enables markets to clear. When, in response to a price drop and volatility, margins are increased and the price subsequently rises, is the raised margin a contributing factor to this rise or does the rise in price happen in spite of a headwind margin effect? The authors suggest that the margin effect can sometimes be supportive: higher margin also can nudge prices higher!

Original title of the article : “Do Security Prices Rise or Fall When Margins Are Raised?”, Jean-Marc Bottazzi, Mário Páscoa and Guillermo Ramírez
Published in: CES, University Paris 1
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