All-in Investors and Unstable Asset Prices

We analyze a setting in which a risky asset is traded by two types of investors: some are all in and buy up to their margin limit and some buy and sell based on the asset's fundamental value. A higher price of the asset increases all-in investor wealth and they borrow against this wealth to buy more shares. All-in investor demand for shares is therefore upward sloping. If all-in investors have (i) enough wealth, and (ii) access to at least 2:1 leverage, then aggregate demand for shares can be upward sloping and an equilibrium price therefore unstable. If P1 is an equilibrium price, then there exists a price P2>P1 that also clears the market. P1 is unstable and P2 is stable. Unfortunately, if the price actually is P2, then it will be unstable and there will exist a P3>P2 that clears the market and is stable. This is true for any arbitrarily high proposed price. Our theory provides an explanation for the prominent and sudden surge in prices in January 2021 for retail stocks such as GameStop Corporation.