Margin Requirements and Evolutionary Asset Pricing

Abstract

We introduce an evolutionary equilibrium asset pricing model with heterogeneous agents who can either act as brokers or hedge funds. Hedge funds can trade on margin, taking short or (leveraged) long positions in the assets. Brokers provide asset loans and credit to margin traders. In any evolutionary equilibrium, where growth rates of wealth under management are identical, assets are priced according to expected relative dividends (the Kelly rule) and margin traders either leverage long or short the Kelly portfolio. Margin requirements affect the equilibrium interest rates but not the level of asset prices. We also apply the model to study the impact of margin requirements on the speed of price adjustment in the presence of noise traders.