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Optimal portfolio choices using financial leverage

Optimal portfolio choices using financial leverage
Optimal portfolio choices using financial leverage
This paper investigates the role of leverage in determining the investor’s optimal asset allocation over multiperiod investment horizons. To do this, we allow investors to lever their financial position by borrowing from credit markets. GMM methods are used to estimate and test the optimal portfolio weights and individual’s optimal choice of financial leverage. These optimal choices are assumed to be parametric functions of a set of state variables describing the evolution of the economy. The empirical application of this methodology to a portfolio of cash, bonds and stocks reveals that a) financial leverage limits the reaction of investors to changes in the investment opportunity set; b) individuals increase leverage during recessions and deleverage in expansionary periods; c) optimal portfolio weights and financial leverage are negatively related to the degree of investor’s risk aversion and positively related to the investment horizon
0307-3378
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Laborda, Ricardo
c50eae59-9323-4cb0-a418-d51dd42c9986
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e

Laborda, Ricardo and Olmo, Jose (2019) Optimal portfolio choices using financial leverage. Bulletin of Economic Research. (doi:10.1111/boer.12215).

Record type: Article

Abstract

This paper investigates the role of leverage in determining the investor’s optimal asset allocation over multiperiod investment horizons. To do this, we allow investors to lever their financial position by borrowing from credit markets. GMM methods are used to estimate and test the optimal portfolio weights and individual’s optimal choice of financial leverage. These optimal choices are assumed to be parametric functions of a set of state variables describing the evolution of the economy. The empirical application of this methodology to a portfolio of cash, bonds and stocks reveals that a) financial leverage limits the reaction of investors to changes in the investment opportunity set; b) individuals increase leverage during recessions and deleverage in expansionary periods; c) optimal portfolio weights and financial leverage are negatively related to the degree of investor’s risk aversion and positively related to the investment horizon

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More information

Accepted/In Press date: 17 August 2019
e-pub ahead of print date: 13 October 2019

Identifiers

Local EPrints ID: 435093
URI: http://eprints.soton.ac.uk/id/eprint/435093
ISSN: 0307-3378
PURE UUID: 8946df11-b741-4b39-b8f1-c0bb680ee146
ORCID for Jose Olmo: ORCID iD orcid.org/0000-0002-0437-7812

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Date deposited: 22 Oct 2019 16:30
Last modified: 07 Oct 2020 02:03

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Contributors

Author: Ricardo Laborda
Author: Jose Olmo ORCID iD

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