Margin Requirements and the Security Market Line

Margin Requirements and the Security Market Line

  • PETRI JYLHÄ

Article first published online: 19th February 2018 DOI: 10.1111/jofi.12616

Abstract


Between 1934 and 1974, the Federal Reserve changed the initial margin requirement for the U.S. stock market 22 times. I use this variation to show that investors' leverage constraints affect the pricing of risk. Consistent with the theoretical predictions of Frazzini and Pedersen (2014), I find that tighter leverage constraints result in a flatter relation between betas and expected returns. My results provide strong empirical support for the idea that the constraints investors face may help explain the empirical failure of the capital asset pricing model.

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