Optimal portfolio leverage

ABSTRACT

The Optimal Portfolio Leverage Ratio provides the level of leverage to use to attain the highest expected long-term terminal value of an investment and is calculated independently of investors’ indifference curves. This article applies a discrete multi-period compounding framework to both discrete and continuous cross-sectional pay-off distributions. In both cases, an Optimal Portfolio Leverage Ratio is derived from first principles and in the case of the latter, a multi-asset solution is also presented. The primary implications for equilibrium asset pricing are considered and a multi-period analogue to the CAPM is derived. This version of the CAPM is to be tested as a joint hypothesis with a specified Optimal Growth Portfolio.

Journal of Asset Management advance online publication, 3 December 2015; doi:10.1057/jam.2015.36

Keywords: multi-period portfolio construction; Kelly rule; optimal portfolio leverage ratio; growth optimal asset pricing

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