Working Paper: NBER ID: w24176
Authors: Rawley Z. Heimer; Alp Simsek
Abstract: Does the provision of leverage to retail traders improve market quality or facilitate socially inefficient speculation that enriches financial intermediaries? We evaluate the effects of 2010 regulations that cap leverage in the U.S. retail foreign exchange market. Using three unique data sets and a difference-in-differences approach, we document that the leverage-constraint reduces trading volume by 23%, alleviates high-leverage traders’ losses by 40%, and reduces brokerages’ operating capital by 25%. Yet, the policy does not affect the relative bid-ask prices charged by the brokerages. These results suggest the policy improves belief-neutral social welfare without reducing market liquidity.
Keywords: leverage restriction; policy; foreign exchange market; retail trading; speculation; consumer financial protection
JEL Codes: G02; G11; G12; G18; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Leverage constraint (D20) | Trading volume (G15) |
| Leverage constraint (D20) | High-leverage traders' losses (F65) |
| Leverage constraint (D20) | High-leverage traders' monthly returns (G12) |
| Leverage constraint (D20) | Brokerages' excess capital (G24) |
| Leverage constraint (D20) | Relative bid-ask spreads (G19) |