Asset Pricing with Dynamic Margin Constraints

Abstract

ABSTRACT This paper provides a novel theoretical analysis of how endogenous time‐varying margin requirements affect capital market equilibrium. I find that margin requirements, when there are no other market frictions, reduce the volatility and correlation of returns as well as the risk‐free rate, but increase the market price of risk, the risk premium, and the price of risky assets. Furthermore, margin requirements generate a strong cross‐sectional dispersion of stock return volatilities. The results emphasize that a general equilibrium analysis may reverse the conclusions of a partial equilibrium analysis often employed in the literature.