Leverage and Performance Metrics in Asset Pricing

31 Pages Posted: 28 Jan 2018 Last revised: 6 Nov 2018

See all articles by Alex R. Horenstein

Alex R. Horenstein

University of Miami - School of Business Administration - Department of Economics

Date Written: October 15, 2018

Abstract

Commonly used performance metrics calculated from tradable long-short strategies constructed using leverage lead to specious conclusions of statistical significance. In particular, even if assets are randomly assigned to the levered strategies' long and short portfolios, too often they generate high Sharpe Ratios and statistically significant CAPM, Carhart, and Fama-French Five Factor alphas. I call this finding the mechanical effect of leverage on performance metrics and suggest various diagnostic tests to control for this effect when testing levered strategies.

Keywords: betting against beta, betting against alpha, factor models, leverage, Sharpe Ratio, alpha

JEL Classification: G10, G12

Suggested Citation

Horenstein, Alex R., Leverage and Performance Metrics in Asset Pricing (October 15, 2018). Available at SSRN: https://ssrn.com/abstract=3107809 or http://dx.doi.org/10.2139/ssrn.3107809

Alex R. Horenstein (Contact Author)

University of Miami - School of Business Administration - Department of Economics ( email )

P.O. Box 248126
Coral Gables, FL 33124-6550
United States

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