Leverage Constraints and Asset Prices: Insights from Mutual Fund Risk Taking

43 Pages Posted: 2 Nov 2014 Last revised: 26 Aug 2016

See all articles by Oliver Boguth

Oliver Boguth

Arizona State University (ASU) - Finance Department

Mikhail Simutin

University of Toronto - Rotman School of Management

Date Written: August 25, 2016

Abstract

Prior theory suggests that time variation in the degree to which leverage constraints bind affects the pricing kernel. We propose a measure for this leverage constraint tightness by inverting the argument that constrained investors tilt their portfolios to riskier assets. We show that the average market beta of actively managed mutual funds -- intermediaries facing leverage restrictions -- captures their desire for leverage and thus the tightness of constraints. Consistent with theory, it strongly predicts returns of the betting-against-beta portfolio, and is a priced risk factor in the cross-section of mutual funds and stocks. Funds with low exposure to the factor outperform high-exposure funds by 5% annually, and for stocks this difference exceeds 8%. Our results show that the tightness of leverage constraints has important implications for asset prices.

Keywords: Leverage constraints, asset prices, betting-against-beta, mutual fund performance, cross-section of stock returns

JEL Classification: G12, G23

Suggested Citation

Boguth, Oliver and Simutin, Mikhail, Leverage Constraints and Asset Prices: Insights from Mutual Fund Risk Taking (August 25, 2016). Rotman School of Management Working Paper No. 2517704. Available at SSRN: https://ssrn.com/abstract=2517704 or http://dx.doi.org/10.2139/ssrn.2517704

Oliver Boguth

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Mikhail Simutin (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.rotman.utoronto.ca/simutin

Register to save articles to
your library

Register

Paper statistics

Downloads
774
Abstract Views
3,480
rank
31,902
PlumX Metrics