In January 2025, Yu-Jane Liu and Juanjuan Meng from Peking University's Guanghua School of Management published a paper in the Review of Financial Studies titled Effects of Credit Expansions on Stock Market Booms and Busts. The research investigates whether credit expansions affect stock prices, a relationship less clear than the established link between mortgage credit and real estate prices. The paper highlights the critical role of powerful investors, like hedge funds, in stock pricing. These investors can offset the influence of margin credit available to retail investors, complicating direct comparisons with the real estate market. This study provides important insights into how credit expansions impact stock market dynamics.

Research Background

The research addresses a crucial topic in financial economics: the impact of credit expansions on asset prices. While there is clear causal evidence linking mortgage credit expansions to rising house prices, the effects of margin lending on stock prices are less straightforward. This complexity arises because stock markets are typically more liquid and influenced by deep-pocketed investors such as hedge funds. Furthermore, significant shocks to margin lending, like those seen in China's market between 2010 and 2015, are rare, making empirical analysis challenging but highly valuable.

Study Overview

The study investigates a major deregulation event in China's stock market, where the government encouraged margin lending to boost stock purchases. This deregulation led to a substantial increase in margin debt, which rose from negligible levels to significant portions of market capitalization. The researchers utilized a combination of event study strategies and regression discontinuity designs to analyze the impact of this credit expansion on stock prices. By examining how margin lending was rolled out across different stocks, the study highlights the anticipatory behavior of institutional investors and the subsequent effects on stock valuations.

Innovative Contributions

This paper's innovative approach lies in its use of Chinese market data to provide causal evidence of margin lending's impact on stock prices. The researchers found that the introduction of margin lending led to a significant, albeit anticipated, increase in stock prices. Institutional investors, particularly mutual funds, played a key role by front-running the anticipated effects of deregulation, adjusting their portfolios accordingly. The study's dynamic stock-pricing model further elucidates how information about credit expansions is gradually priced into the market, offering a nuanced understanding of the relationship between credit and asset prices.

Conclusions

The research concludes that major credit expansions, like those in China's stock market, can significantly drive up equity prices, contributing to market booms. The findings suggest that such expansions play a meaningful role in both the ascent and the subsequent descent of market cycles. The study provides empirical support for the notion that margin lending can amplify stock market fluctuations, highlighting the critical role of regulatory frameworks in managing financial stability.

About the Author

Professor Yu-Jane Liu is a prominent academic at Peking University, serving as a Boya Distinguished Professor and a Finance Professor at the Guanghua School of Management, where she also leads the Financial Development Research Center. Her research, which chiefly focuses on behavioral finance, market microstructure, wealth management, and quantitative investment products, has led to ten publications in top international journals, such as the Journal of Financial Economics and the Review of Financial Studies, and 46 more in other high-level journals. Her work has been cited 4,265 times on Google Scholar, with commendations from Nobel laureate Daniel Kahneman and features in major media like Business Week and Forbes. In 2017, she earned the China Financial Research Outstanding Contribution Award, among many other honors. Her extensive involvement in policy and regulation, particularly in behavioral finance and market systems, includes collaborations with the China Securities Regulatory Commission and the Shanghai Stock Exchange. Additionally, Professor Liu has been active in reviewing for prestigious journals and participating in finance conferences and has served as an expert committee member for the China Financial Futures Exchange, along with advisory roles in the financial industry.

Professor Juanjuan Meng is a distinguished faculty member at Peking University's Guanghua School of Management, where she serves as the Chair of the Department of Applied Economics. She also directs the Behavioral Science and Policy Intervention Research Center at Peking University and is a convener of the Guanghua Behavioral Science and Policy Intervention Cross-Innovation Team. Professor Meng's research encompasses behavioral economics, with a focus on behavioral interventions and policy design in the digital economy. Her work has been published in leading journals such as American Economic Review, Management Science, and Journal of Public Economics. In addition to her academic achievements, she holds editorial positions with eminent journals and has been awarded numerous prestigious grants, including the National Science Fund for Distinguished Young Scholars. Her contributions extend beyond academia, influencing economic policy design through innovative research and leadership.