Leverage management in a bull-bear switching market

Min Dai, Hefei Wang, Zhou Yang

Research output: Journal article publicationJournal articleAcademic researchpeer-review

2 Citations (Scopus)

Abstract

Should an investor unwind his portfolio in the face of changing economic conditions? We study an investor's optimal trading strategy with finite horizon and transaction costs in an economy that switches stochastically between two market conditions. We fully characterize the investor's time dependent investment strategy in a "bull" market and a "bear" market. We show that when the market switches from the "bull" market to the "bear" market, complete deleveraging, reducing the degree of leverage, or keeping leverage unchanged may all be optimal strategies, subject to underlying market conditions. We further show that the investor may optimally keep leverage unchanged in the "bear" market, particularly so for illiquid asset. On the other hand, a lower borrowing cost in the "bear" market would prevent sell offs.

Original languageEnglish
Pages (from-to)1585-1599
Number of pages15
JournalJournal of Economic Dynamics and Control
Volume36
Issue number10
DOIs
Publication statusPublished - Oct 2012

Keywords

  • Bull-bear switching market
  • Leverage
  • Portfolio selection
  • Transaction costs

ASJC Scopus subject areas

  • Economics and Econometrics
  • Control and Optimization
  • Applied Mathematics

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