The Limits of Leverage

32 Pages Posted: 7 Jun 2014 Last revised: 11 Sep 2016

See all articles by Paolo Guasoni

Paolo Guasoni

Dublin City University - School of Mathematical Sciences; Boston University - Department of Mathematics and Statistics

Eberhard Mayerhofer

University of Limerick - Department of Mathematics and Statistics

Multiple version iconThere are 2 versions of this paper

Date Written: September 10, 2016

Abstract

When trading incurs proportional costs, leverage can scale an asset's return only up to a maximum multiple, which is sensitive to its volatility and liquidity. In a model with one safe and one risky asset, with constant investment opportunities and proportional costs, we find strategies that maximize long term return given average volatility. As leverage increases, rising rebalancing costs imply declining Sharpe ratios. Beyond a critical level, even returns decline. Holding the Sharpe ratio constant, higher asset volatility leads to superior returns through lower costs.

Keywords: leverage, transaction costs, portfolio choice, performance evaluation

JEL Classification: G11, G12

Suggested Citation

Guasoni, Paolo and Mayerhofer, Eberhard, The Limits of Leverage (September 10, 2016). Available at SSRN: https://ssrn.com/abstract=2446817 or http://dx.doi.org/10.2139/ssrn.2446817

Paolo Guasoni (Contact Author)

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

HOME PAGE: http://www.guasoni.com

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Eberhard Mayerhofer

University of Limerick - Department of Mathematics and Statistics ( email )

Castletroy, Co
Limerick
Ireland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
373
Abstract Views
2,072
rank
97,321
PlumX Metrics