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Actuarial Sciences and Quantitative Finance

Type of publication Peer-reviewed
Publikationsform Book (peer-reviewed)
Author Leiss Matthias, Nax Heinrich H.,
Project The Anatomy of Systemic Financial Risk: Combining Ethical, Political and Economic Dimensions for Public Policy
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Book (peer-reviewed)

Publisher Springer International Publishing, Cham
ISBN 978-3-319-66534-4
DOI 10.1007/978-3-319-66536-8

Abstract

Leverage has been shown to be procyclical and indicative of financial market risk. Here, we present a novel, inherently forward-looking way to estimate market leverage ratios based on derivative prices, option hedging, and the ‘operational’ riskiness measure by Foster and Hart (J Polit Econ 117(5):785–814, 2009). Furthermore, we report option-implied ‘optimal’ leverage levels inferred via the (Kelly, IRE Trans. Inf. Theory 2(3):185–189, 1956) criterion. The resulting measure of leverage exhibits strong procyclicality prior to the Global Financial Crisis of 2008. Finally, we find it to successfully predict large stock market downturns.
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