Why Can Margin Requirements Increase Volatility and Benefit Margin Constrained Investors?

We propose a tractable equilibrium model to examine how margin requirements affectasset prices, market volatility, and market participants' welfare. Weshow that margin requirements can have opposite effects on market volatility whenthey constrain different investors and thus can help explain why empirical results havebeen mixed. Contrary to one of the main regulatory goals, we find that even thoughmargin requirements restrict borrowing and shorting, they can significantly increasemarket volatility. In addition, margin requirements can make marginconstrained investors better off and canlead to a greater return reversal. Our analysis also provides new empirically testable implications