Should retail investors’ leverage be limited?

Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? We evaluate the effects of 2010 regulations that cap leverage in the U.S. retail foreign exchange market. Using three unique data sets and a...

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Bibliographic Details
Published in:Journal of financial economics 2019-06, Vol.132 (3), p.1-21
Main Authors: Heimer, Rawley, Simsek, Alp
Format: Article
Language:English
Subjects:
Brokerage
Capital
Consumer financial protection
Foreign exchange
Foreign exchange market
Foreign exchange markets
Foreign exchange rates
Investors
Leverage
Leverage restriction policy
Liquidity
Prices
Regulation
Retail trading
Retailing industry
Social welfare
Speculation
Trading
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Summary:Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? We evaluate the effects of 2010 regulations that cap leverage in the U.S. retail foreign exchange market. Using three unique data sets and a difference-in-differences approach, we document that the leverage-constraint reduces trading volume by 23%, alleviates high-leverage traders’ losses by 40%, and reduces brokerages’ operating capital by 25%. Yet, the policy does not affect the relative bid-ask prices charged by the brokerages. These results suggest the policy improves belief-neutral social welfare without reducing market liquidity.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2018.10.017