The impact of margin trading on share price evolution: A cascading failure model investigation

TL;DR

This paper introduces a cascading failure model to analyze how margin trading factors influence stock market vulnerability, revealing conditions that lead to market stability or collapse, with implications for regulatory oversight.

Contribution

The study develops a novel bipartite graph-based cascading failure model incorporating four margin trading factors to simulate and analyze market stability.

Findings

Increasing volatility and minimum maintenance raise failure risk.

Lower initial margin increases vulnerability.

Higher diversity decreases market resilience.

Abstract

Margin trading in which investors purchase shares with money borrowed from brokers is blamed to be a major cause of the 2015 Chinese stock market crash. We propose a cascading failure model and examine how an increase in margin trading increases share price vulnerability. The model is based on a bipartite graph of investors and shares that includes four margin trading factors, (i) initial margin $k$, (ii) minimum maintenance $r$, (iii) volatility $v$, and (iv) diversity $s$. We use our model to simulate margin trading and observe how the share prices are affected by these four factors. The experimental results indicate that a stock market can be either vulnerable or stable. A stock market is vulnerable when an external shock can cause a cascading failure of its share prices. It is stable when its share prices are resilient to external shocks. Furthermore, we investigate how the cascading failure of share price is affected by these four factors, and find that by increasing $v$ and $r$ or decreasing $k$ we increase the probability that the stock market will experience a phase transition from stable to vulnerable. It is also found that increasing $s$ decreases resilience and increases systematic risk. These findings could be useful to regulators supervising margin trading activities.