Abstract
In a pure-exchange, continuous-time economy, agents, who have different subjective discount rates and heterogenous beliefs on the fundamentals, trade with each other motivated not only by the benefit of risk sharing but also by speculation. This aggressiveness in trading can increase stock price volatility under some conditions. Margin requirements limit agents' ability to speculate, thus they tend to reduce the stock price volatility in general, especially when agents' beliefs are more divergent. Furthermore, if the margins are binding, an increase in margins leads to a decrease in stock volatility in the case when the patient agent is relatively optimistic and lead to an increase in stock volatility when the patient agent is relatively pessimistic. Margin requirements also stabilize the redistribution of wealth caused by the trading (speculating) of stocks and alter the equilibrium interest rates. Some dynamic implications of margin requirements are also explored through a simulated example.
Published Version
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