The efficacy of buying stocks on margin

Date

2016-08

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Abstract

In this paper, I explore the historical return distributions of various levered investment strategies in equities and test whether investing in stocks using broker’s call loans (on margin) is more effective than investing in stocks on a cash only basis. Using the CRSP value weighted index as well as randomly selected portfolios of stocks formed using CRSP data as test assets, I simulate investment on margin using the rules that brokers impose on investors. The returns on these simulations are estimated for both annual and monthly holding periods over the period from 1974 to 2013. Overall the results are mixed. When using the CRSP value-weighted index as a test asset utilizing leverage is always more effective than investing in stocks on an unlevered basis. For portfolios, the results suggest that buying stocks on margin does not produce superior risk-adjusted returns relative to investing in stocks on a cash-only basis. In addition, research has shown that time variation in risk premiums exist. I examine one such strategy that aims to take advantage of this time variation by using changes in Federal Reserve policy rates as buy and sell signals to invest in stocks on margin. The results are once again mixed. When using the CRSP value-weighted index, levered investment is more effective than unlevered investment over restrictive policy periods, not expansive periods. Using portfolios of stocks as test assets, I find that investing in stocks on margin is not more effective than investing in stocks on cash, regardless of the policy stance of the Fed. Finally, I study the impact of different broker call rates and maintenance margins and how they impact the historical return distributions of the various levered investment strategies in equities.

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Keywords

Asset Pricing, Investments, Margin, Leverage, Stocks, Monetary Policy

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