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Leverage management in a bull–bear switching market


  • Dai, Min
  • Wang, Hefei
  • Yang, Zhou


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.

Suggested Citation

  • Dai, Min & Wang, Hefei & Yang, Zhou, 2012. "Leverage management in a bull–bear switching market," Journal of Economic Dynamics and Control, Elsevier, vol. 36(10), pages 1585-1599.
  • Handle: RePEc:eee:dyncon:v:36:y:2012:i:10:p:1585-1599 DOI: 10.1016/j.jedc.2012.04.004

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    References listed on IDEAS

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    More about this item


    Leverage; Portfolio selection; Bull–bear switching market; Transaction costs;

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis


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