Abstract
Leveraged trading exhibits the characteristics of “strong margin trading and weak short selling” in the Chinese stock market. On the basis of monthly data on leveraged trading in the Chinese stock market from January 2014 to December 2016, we aim to empirically examine the relationship between leveraged trading and investor sentiment, and analyze the characteristics of investor sentiment contained in the leverage ratio. The results show that (1) as the leverage ratio increases, the pattern of investor trading changes from the positive feedback trading of “chasing up and down” to the negative feedback trading of “selling high and buying low”; (2) leveraged trading has the typical characteristics of irrational sentiment; (3) inverse arbitrage strategies based on leverage ratios is effective in one month in the Chinese market. The findings in this paper provide empirical support for clarifying the influence mechanism between leveraged trading and investor sentiment, and can serve as a useful reference for reducing the impact of leveraged trading on volatility and maintaining the sustainability of the stock market.
Highlights
In the stock market, leveraged trading refers to transactions in which investors use their own funds as a guarantee to obtain margin trading or short selling from banks or brokers to amplify transaction values
Abnormal volatility is defined as the portion of the volatility of asset prices that exceeds the boundary of the volatility of fundamental factors (Shiller, [2]).) in the Chinese stock market indicated that the leveraged trading was having a significant impact on investor sentiment and volatility, and was even threatening sustainability in the stock market [3,4]
If leveraged trading is an important factor that affects investor sentiment, does leveraged trading reflect the characteristics of investors’ rational or irrational sentiments? This paper reports an empirical study on the relationship between leveraged trading and investor sentiment: The first aspect was explored by testing whether the sentiment feedback coefficient is significantly negatively correlated with the leverage ratio; the second aspect was examined by using the three properties of sentiment [12] to determine whether the leverage ratio has the typical characteristics of irrational sentiment
Summary
In the stock market, leveraged trading refers to transactions in which investors use their own funds as a guarantee to obtain margin trading or short selling from banks or brokers to amplify transaction values. Abnormal volatility is defined as the portion of the volatility of asset prices that exceeds the boundary of the volatility of fundamental factors (Shiller, [2]).) in the Chinese stock market indicated that the leveraged trading was having a significant impact on investor sentiment and volatility, and was even threatening sustainability in the stock market [3,4]. Since the introduction of the leveraged trading system in China, insufficient securities sources, the high cost of securities lending, and excessive optimism of investors during the bull market have caused the volume of short selling to be far smaller than that of margin trading. Leveraged trading lacks a role in the elimination of short selling restrictions, and further exacerbates short-selling restrictions because of its asymmetry, thereby forming a positive price feedback effect that causes abnormal volatility and even price crashes, which threaten sustainability in the stock market
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