Leverage constraints and investors' choice of underlyings

Abstract

This paper investigates the impact of a 2018 intervention by the European Securities and Markets Authority (ESMA), which limits the amount of leverage that retail investors can take on their trading activities. While the intervention successfully reduced leverage-usage, investors shifted their trading activities to riskier assets in the process, consistent with the idea that leverage-constrained investors substitute leverage with riskier securities. Thus, the intervention was not as effective as the reduction in leverage suggests.