Impact Of Margin Trading On The Quality Of China Stock Markets

Margin policy allows investors to buy or sell securities by funding funds from brokers or security companies. On March 31st in 2010, the pilot project of margin trading business marked an end to the "unilateralism" situation on A stock market, and all investors have embraced the new era. Loan trading business’approval by China Security Regulation Committee further accelerated the expansion of margin trading volume. In 2014, the average margin trading volume has reached ￥20 billion per day. However, the effects of margin trading policy on market qualities still remain debatable due to previous related researches.This paper first analyzes the mechanism for margin trading and loan trading business to affect the liquidity and volatility of stock markets. According to the model developed by Schwert (1990), market return volatility can be decomposed into transitory and permanent components, and each component have displayed different sensitivity to the scale of margin trading business. Theoretically, market liquidity will be improved on the background of margin trading business, since it provides higher leverage and bilateral profitability mechanism, which will magnify the market trading volume and allow security supply and demand to be matched more easily. Based on the margin trading data of listed companies on A stock markets, this paper tested how margin trading affected the liquidity and volatility of stock markets. Liquidity effect is tested on VAR model. T-GARCH and AC-GARCH model are utilized to explain the market volatility, considering the asymmetric volatility phenomenon and decomposition of volatility.The empirical study show that there is a significant positive effect between margin trading mechanism and market liquidity, and specifically, margin buying improved the market liquidity in the early stage, while recently margin selling show great effects on the liquidity improvement. This phenomenon might be related to the fact that more small and medium companies are incorporated in margin trading pilot project list. In line with theoretical prediction, margin trading reduces the market volatility in general. Specifically, it increases the transitory part of volatility since it magnifies noise trading volume in the short run, and decrease the permanent component of volatility through enhancing the rational arbitrage power in the long run. Further tests on the loan trading policy show that margin selling is negatively related to the market volatility, while no significant relation is observed between margin buying business and market quality, In conclusion, margin trading is an important mechanism in stock market and it laid a solid foundation on the sustainable development of China’s stock market. However, margin trading policy is still on the initial stage, and a lot more works need to be done. This paper suggests that regulators should actively promote the establishment of credit rating system and dynamic regulation mechanism. Institutional investors should also play a vital role during the development of margin trading system.