Leveraged speculators and asset prices†

Wenxi Jiang

Review of Finance, 2024, vol. 28, issue 3, 769-804

Abstract: I test the hypothesis that the use of leverage by market speculators can increase the likelihood and magnitude of crashes in asset prices. Using a direct leverage measure derived from US public filings, I find that (1) stocks held by highly leveraged hedge funds subsequently have more negatively skewed returns than stocks held by less leveraged funds and (2) upon extremely negative earnings surprises or funding liquidity shocks, stocks owned by high-leverage funds exhibit abnormal price declines and subsequent reversal. Consistent with the fire sale and contagion hypothesis, high-leverage funds tend to reduce the position following negative news about a stock, and such selling can extend to other stocks in the portfolio, increasing the crash proneness of the stocks they hold.

Keywords: hedge fund leverage; price crash; return skewness; fire sales (search for similar items in EconPapers)
JEL-codes: G12 G23 (search for similar items in EconPapers)
Date: 2024
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