Co-Collateral Risk

This paper proposes a novel measure of stock-level margin constraints to study the impact of funding risk on the cross-section of stock returns. More specifically, we use daily cash collateral information collected from the short selling market to construct the measure, and decompose it into two components reflecting either co-movements in margin requirements (co-collateral risk) or idiosyncratic variations. Since co-collateral risk tightens margin constraints faced by major traders, it is expected to be associated with positive return premium. We test this implication for available U.S. stocks, and indeed find a significantly positive relationship between co-collateral risk and out-of-sample stock returns. The strategy of buying/shorting stocks with top/bottom 10% co-collateral betas can deliver an annualized DGTW-adjusted return of 6%. Additional tests further confirm that co-collateral beta imposes constraints on short-selling activities and that our results are not explained by a list of asset pricing anomalies