Leverage and Beliefs: Personal Experience and Risk Taking in Margin Lending

Out­line

Lever­age in fi­nan­cial mar­kets is not con­stant over time. Lend­ing is typ­i­cal­ly pro-cycli­cal – high and in­creas­ing in good times, and much low­er when as­set prices fall. For ex­am­ple, when the stock mar­ket crashed af­ter Lehman’s bank­rupt­cy in 2008, “hair­cuts” in­creased sharply and the vol­ume of col­lat­er­al­ized lend­ing col­lapsed. Pro-cycli­cal “lever­age cy­cles” af­fect the risk-bear­ing ca­pac­i­ty of fi­nan­cial in­ter­me­di­aries and can con­tribute to large changes in as­set prices. The source of these im­por­tant changes is less clear.

Mar­gin loans in 18-cen­tu­ry Am­s­ter­dam

What de­ter­mines risk-bear­ing ca­pac­i­ty and the amount of lever­age in fi­nan­cial mar­kets? Us­ing hand-col­lect­ed data from no­tary archives, we fo­cus on mar­gin loans in the 18-cen­tu­ry Am­s­ter­dam stock mar­ket. When an in­vestor syn­di­cate spec­u­lat­ing in Am­s­ter­dam in 1772 went bank­rupt, many lenders were ex­posed. In the end, none of them ac­tu­al­ly lost mon­ey. Nonethe­less, only those at risk of los­ing mon­ey changed their be­hav­ior marked­ly – they lent with much high­er hair­cuts. The rest con­tin­ued as be­fore. The dif­fer­en­tial change is re­mark­able since the dis­tress was pub­lic knowl­edge. Over­all lever­age in the Am­s­ter­dam stock mar­ket de­clined as a re­sult.

Our re­sults strong­ly sug­gest that in­di­vid­ual risk tak­ing can change sub­stan­tial­ly as a re­sult of per­son­al ex­pe­ri­ence, even with­out changes to wealth – and that such changes do not only arise among re­tail in­vestors, but among so­phis­ti­cat­ed mar­ket par­tic­i­pants. Im­por­tant­ly, we also show that per­son­al ex­pe­ri­ence can change in­vestor be­hav­ior in a ma­jor way, caus­ing sig­nif­i­cant shifts in ag­gre­gate out­comes such as mar­ket-wide lever­age.

Re­search Team

Author

Joachim Voth

Professor of Macroeconomics and Financial Markets, endowed by the UBS Center

Zurich ZCED

Pe­ter Koudi­js

Stan­ford GSB