Did Margin Rules and Financial Development Affect Returns and Volatility During the Market Crash of 2007–2008?

Abstract

This article aims to determine if the type of margin rules on an exchange or financial development contributed to or dampened the stock market returns or volatility of returns during the worldwide market sell-off from October 16, 2007 to October 22, 2008. The author finds that rigid margin rules significantly reduced the weekly index return volatility during the crash period and also reduced the change in weekly index return volatility compared to the past 5 years. There is no evidence that margin rules had any impact on returns during the crash period, refuting the pyramiding hypothesis. Return volatility was positively related to financial development during the crash period but negatively related to volatility before the crash period, suggesting that the cause of the crash centered in the financially developed world. Regulators from around the world would be interested in how margin rules on different exchanges can increase or dampen returns or volatility during extreme market movements and how financial development interacts with return volatility during extreme market conditions. <b>TOPICS:</b>Volatility measures, performance measurement, financial crises and financial market history