Optimal portfolio choices using financial leverage.

R. Laborda and J. Olmo (2020). Optimal portfolio choices using financial leverage. Bulletin of Economic Research 72, 146-166.

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 nancial position by borrowing from credit markets. GMM methods are used to estimate and test the optimal portfolio weights and individual's optimal choice of nancial 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) nancial 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 nancial leverage are negatively related to the degree of investor's risk aversion and positively related to the investment horizon.

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