Margin Trading and Stock Idiosyncratic Volatility: Evidence from the Chinese Stock Market, a paper co-authored by our school’s Assistant Professor Zhu Yifeng, and postgraduate student Gui Pingshu from the Department of World Economics and Politics of the Graduate School of CASS, was officially accepted by International Review of Economics and Finance, a prestigious journal in the field of finance. Gui was a bachelor of international finance who graduated from our school in 2019, and enrolled in our school’s sixth outstanding academic talent program for bachelors.
This paper looks into the idiosyncratic volatility effect. In previous literature, many scholars explained the effect by focusing on arbitrage asymmetry caused by short-selling constraint and the maximum daily return effect. Inspired by this, the paper considers the impact of short-selling constraint, heterogeneous beliefs and gambling behaviors on idiosyncratic volatility. Margin trading was introduced in the Chinese stock market in March 2010, which provides a natural experiment for the paper. Using margin trading stocks (the “underlying stocks”) as the experimental group and non-margin trading stocks (the “non-underlying stocks”) as the control group, this paper analyzes the formation mechanism of idiosyncratic volatility using the difference-in-differences (“DID”) model and Fama-MacBeth cross-sectional regressions.
The research shows that: (1) Overall, there exists idiosyncratic volatility in the Chinese stock market which cannot be explained by other variables. However, when stocks are divided into underlying and non-underlying stocks, the idiosyncratic volatility effect of the former can be explained by turnover rate. This indicates that idiosyncratic volatility of underlying stocks mainly originates from heterogeneous beliefs, because short-selling constraint suppresses the expression thereof. Yet idiosyncratic volatility of non-underlying stocks cannot be explained, and is more subject to other factors than heterogeneous beliefs. (2) Gambling behaviors involving underlying stocks are fewer than those involving non-underlying stocks. Because on the one hand, the lottery characteristics of underlying stocks are weaker - as they show a larger turnover, stronger liquidity and lower volatility; on the other hand, some investors are under short-selling constraint, so they prefer “gambling” on non-underlying stocks. (3) Under the DID model, the paper finds that after the margin trading mechanism is introduced, idiosyncratic volatility of underlying stocks is notably reduced, and such result still holds after a series of factors are considered. And the inhibiting effect on stock idiosyncratic volatility mainly comes from margin trading. Therefore, introducing the margin trading mechanism is conducive to correcting stock prices in the Chinese stock market.