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Abstract

Using Japanese long sample (1977–2010) market data, we examine whether margin buying is informed trades about future stock returns and whether they are related to undervaluation of the market. We find that margin buying increases when temporary returns are higher contemporaneously. We do not find that Japanese margin buying is well-informed in predicting future permanent changes in stock returns. Further, we find that margin buying is not related to the undervaluation of stock market prices.

5. Conclusions

We have examined whether margin buying represents informed trading about future stock returns and whether it is related to the undervaluation of the market. For the empirical estimation, we use Japanese long-sample (1977–2010) market data. Our findings about margin buying in Japan can be summarized as follows. First, margin buying is significantly positively related to temporary returns but not to permanent returns, implying that margin buying increases when temporary returns are higher contemporaneously. Second, margin buying tends to increase mainly in response to past higher (temporary) returns. It is quite interesting to find that margin buying is not really related to future increases in returns, which implies that margin buyers are not well-informed investors for future stock market returns. Third, we fail to find any significant evidence that margin buying is related to undervaluation of stock market prices. Regarding the relation between margin buying and short sales in Japanese market, we find evidence of some asymmetric relation between short sales and margin buying. An increase in margin buying tends to substitute short sales, particularly in the long term; however, an increase in short sales does not seem to substitute margin buying, including the concurrent effect in particular. This asymmetric relation between short sales and margin buying may be related to the finding that margin buyers are not well-informed relative to short sellers or could be due to some complementary relation as Jarrow (1980) points out. The above findings imply that margin buyers are not well-informed investors for future stock market returns and margin buying is just a market sentiment that is not a driving force of stock price. Given that margin buying is not related to undervaluation and future increase in returns, we understand that margin buying does not destabilize the stock market. Its policy implication is that strict regulation of margin buying may not be needed, in particular, considering that margin buying tends to provide liquidity to short sellers.