Using daily account-level data that track hundreds of thousands of margin investors' leverage ratios and trading activities, we examine the effect of margin-induced trading on stock return dynamics during the recent market turmoil in China. We start by providing direct evidence of deleverging-induced sales - the tendency to scale down levered positions after experiencing negative portfolio returns. Aggregating this behavior across all margin investors, we document a strong return spillover effect - a stock's return can be forecasted by a portfolio of stocks with which it shares common margin-investor ownership. This return pattern is subsequently reversed, and is present only in market downturns. Further, deleveraging-induced selling can explain a large portion of the well-known asymmetry in stock return comovement between market booms and busts. Finally, exploiting three bailout waves carried out by the Chinese government, we provide additional evidence for a) the shock transmission role of the leverage network, and b) the systematic importance of stocks that are central in the network.

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