Broker-dealer leverage volatility and the US stock prices

Abstract

PurposeBroker-dealer leverage volatility increases during booms and crisis periods, but its impact on stock prices is relatively unexplored. This paper aims to investigate whether broker-dealer leverage volatility is a key driver for stock prices.Design/methodology/approachThis paper collects the US quarterly data of broker-dealer book leverage and three leading stock market indicators (S&P 500, DJIA and Nasdaq) for the period of 1967–2018. The research uses a multivariate GARCH-in-mean VAR to examine the impact of leverage volatility on each of the stock market indicators. A split-sample analysis (pre-1990 and post-1990) has also been performed to show the robustness of the result.FindingsThe research finds that broker-dealer leverage volatility does not have any significant impact on stock prices.Originality/valueBroker-dealers are important financial intermediaries, and there is a huge literature exploring the relationship between their leverage and asset prices. But, the relationship between broker-dealer leverage volatility and asset prices is not explored yet. This study fills the gap and provides the first evidence that broker-dealer leverage volatility does not play any major role in the theory of stock pricing. The research proposes that the stock holding decisions of the investors should depend only on the first moment of leverage and not on the second moment of leverage. The study concludes that high broker-dealer leverage volatility is not a sinister signal for the US stock market.