Effects of Credit Expansions on Stock Market Booms and Busts
Credit expansions are commonly associated with elevated stock market valuations. However, relative to other markets, isolating the causal relationship is challenging. Due to margin restrictions, easy credit often leaks into stock prices in difficult-to-measure ways. We address this by examining a large-scale deregulation in China that explicitly liberalized margin lending. Regression discontinuity and event study estimates show that this deregulation caused a sizable increase in the level of asset prices, which was largely anticipated by unconstrained investors. We develop an easy-to-estimate model of stock prices with anticipation to quantify the importance of expectations regarding financial liberalizations and credit expansions.
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