Ulric B. and Evelyn L. Bray Seminar

What determines leverage in financial markets? Using data from the Dutch stock market in the 1770s, we examine a hand-collected sample of collateralized loan covenants involving repos by stock market investors. An investor syndicate speculating in English stocks had become distressed. Lenders to this consortium where at risk of losses, but they never materialized – all of them were repaid in full. We show that after the distress period, these investors only lent at higher haircuts. Interest rates were unaffected and the market balanced solely through an increase in haircuts. These were exclusively driven by lenders exposed to the failed syndicate altering their behavior. This change itself is remarkable since none of them suffered actual losses. The paper demonstrates that lenders exposed to the ill-fated investors are indistinguishable before the distress period, but behave differently thereafter. The findings are consistent with a differences-of-beliefs interpretation of leverage.