Traditional Optimization Is Not Optimal for Leverage-Averse Investors

Leverage entails a unique set of risks, such as margin calls, which can force investors to liquidate securities at adverse prices. Investors often seek to mitigate these risks by using a leverage constraint in conventional mean-variance portfolio optimization. Mean-variance optimization is unable to...

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Bibliographic Details
Published inJournal of portfolio management Vol. 40; no. 2; p. 30
Main Authors Jacobs, Bruce I, Levy, Kenneth N
Format Journal Article
LanguageEnglish
Published London Pageant Media 01.01.2014
Subjects
Adverse selection
Investors
Leverage
Optimization
Optimization techniques
Portfolio management
Standard deviation
Studies
Utility functions
Variance analysis
Volatility
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Summary:Leverage entails a unique set of risks, such as margin calls, which can force investors to liquidate securities at adverse prices. Investors often seek to mitigate these risks by using a leverage constraint in conventional mean-variance portfolio optimization. Mean-variance optimization is unable to identify the portfolio offering the highest utility, however, because it provides the investor with little guidance as to where to set the leverage constraint. An alternative approach-the mean-variance-leverage optimization model-lets the leverage-averse investor determine the optimal leverage level (and thus the highest-utility portfolio) by balancing the portfolio's expected return against the portfolio's volatility risk and its leverage risk. [PUBLICATION ABSTRACT]
ISSN:0095-4918
2168-8656
DOI:10.3905/jpm.2014.40.2.030