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Research Insight - Managing the Unique Risks of Leverage with the Barra Optimizer - July 2014

Jacobs and Levy recently published a series of papers on “leverage aversion” and the benefits of incorporating it in the traditional Markowitz Mean-Variance Optimization.  They emphasize the uniqueness of leverage risk, in contrast to volatility risk.  Their debate with Markowitz has sparked renewed interest in the theory and application of long-short optimization.  In this Research Insight, we point out that MSCI has been a pioneer in long-short portfolio optimization since the early 1990s. In practice, “leverage aversion” is a leverage penalty term in the Barra Optimizer; thus, Jacobs and Levy’s recent findings are a strong validation of an existing MSCI product.