Working Paper

Can Leverage Constraints Help Investors?


Abstract: This paper provides causal evidence that leverage constraints can reduce the underperformance of individual investors. In accordance with Dodd-Frank, the CFTC was given regulatory authority over the retail market for foreign exchange and capped the maximum permissible leverage available to U.S. traders. By comparing U.S. traders on the same brokerages with their unregulated European counterparts, I show that the leverage constraint reduces average per-trade losses even after adjusting for risk. Since this causal approach holds constant contemporaneous market factors, these findings challenge the concept that individuals are better off when they are unconstrained in their risk-taking.

Keywords: Retail Foreign Exchange; Individual Investors; Financial Market Regulation; Leverage Constraints;

JEL Classification: G11; G02; G18;

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Bibliographic Information

Provider: Federal Reserve Bank of Cleveland

Part of Series: Working Papers (Old Series)

Publication Date: 2014-12-03

Number: 1433

Pages: 48 pages