Embedded Leverage

Andrea Frazzini, Lasse Heje Pedersen

Research output: Contribution to journalJournal articleResearchpeer-review


Many financial instruments are designed with embedded leverage, such as options and leveraged exchange-traded funds (ETFs). Embedded leverage alleviates investors’ leverage constraints, and, therefore, we hypothesize that embedded leverage lowers required returns. Consistent with this hypothesis, we find empirically that options and leveraged ETFs provide significant amounts of embedded leverage; this embedded leverage increases return volatility in proportion to the embedded leverage; and higher embedded leverage is associated with lower risk-adjusted returns. The results are statistically and economically significant, and we provide extensive robustness tests and discuss the broader implications of embedded leverage for financial economics.
Original languageEnglish
JournalThe Review of Asset Pricing Studies
Number of pages65
Publication statusPublished - 27 Sep 2021

Bibliographical note

Epub ahead of print. Published online: 22 September 2021.

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