Margin Trading and Stock Idiosyncratic Volatility: Evidence from the Chinese Stock Market

Abstract

In this paper, we find that the idiosyncratic volatility (IV) effect on expected returns exists and cannot be explained by other variables in the Chinese stock market. The Chinese stock market launched margin trading in March 2010. We therefore study the margin trading target and non-margin trading target stocks separately and find that the IV effect exists in both stock groups. The IV effect of the margin trading target stocks can be explained by the turnover ratio, whose mechanism shows that the short sale constraint hinders the expression of the seller’s heterogeneous beliefs. However, the IV effect of the non-margin trading target stocks cannot be interpreted by other variables. In comparison to margin trading target stocks, non-margin trading target stocks are more likely to have the lottery characteristics and their gambling behavior is more pronounced.

Keywords: Idiosyncratic volatility; Margin trading; Short sale constraint; Heterogeneous beliefs; Gaming behavior.