The potential built-in supply effect from margin trading in the Chinese stock market

Abstract

Utilizing a unique daily data set, we examine how the covering of margin positions affects earnings announcement returns in the Chinese stock market dominated by retail traders. Unlike previous research on forced covering during price crashes, we propose that margin interest acts as a built-in supply and find that intensive covering of margin positions pushes down stock prices during earnings announcements of extreme good news. The release of built-in supply leads to stronger post-earnings-announcement drift (PEAD) after good news compared with that after bad news, consistent with investors’ tendency to realize profits after a gain under the disposition effect.