Testing market regulations in experimental asset markets - the case of margin purchases

Abstract

Margin requirements regulate the risks of leveraged positions in financial markets. Violated margin requirements trigger margin calls leading to automated liquidation of open margin positions. Due to a lack of active margin regulation, however, empirical studies are not able to capture the effect of margin regulation on asset market performance. Instead, we conduct an experimental finance study to understand how margin regulations, and in particular margin purchases, influence market performance. Our experimental results indicate that permitting margin purchases inflates market prices; in fact, active margin trading positively correlates with market prices. In a robustness check, we also permit short sales which curb though not eliminate the effects from margin purchases.