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Leverage: Difference between revisions
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In financial analysis, the effect of leverage is assigned the Greek character [[vega]]. This is to distinguish it from “[[beta]]” — the market’s performance as a whole — and “[[alpha]]” — an individual portfolio’s performance, without taking account of the effects of leverage, measured against the market [[beta]]. | In financial analysis, the effect of leverage is assigned the Greek character [[vega]]. This is to distinguish it from “[[beta]]” — the market’s performance as a whole — and “[[alpha]]” — an individual portfolio’s performance, without taking account of the effects of leverage, measured against the market [[beta]]. | ||
Positive “[[alpha]]” is extremely hard — some would say impossible, over an extended period — to generate. It requires the skill of a {{strike| | Positive “[[alpha]]” is extremely hard — some would say impossible, over an extended period — to generate. It requires the skill of a {{strike|Meriwether,|}} {{strike|Scholes,|}} {{strike|Fuld,|}}{{strike|Skilling,|}} {{strike|Huang,|}} Soros or Buffett. [[Vega]], on the other hand, is really easy to generate, as long as you have someone credulous to borrow from. | ||
From a distance it is easy — and, when the portfolio is doing well, ''tempting'' — to confuse alpha and vega | From a distance it is easy — and, when the portfolio is doing well, ''tempting'' — to confuse [[alpha]] and [[vega]], and many [[hedge fund]] managers do. There is a survivor bias problem here of course, because hedge fund managers do not often get the opportunity to talk about their negative alpha performance, because by the time it happens, the fund has typically imploded. | ||
It was leverage, not anything more difficult to understand than that, that caused the implosion of LTCM, the global financial crisis, and the [[Archegos]] affair. | It was leverage, not anything more difficult to understand than that, that caused the implosion of LTCM, the global financial crisis, and the [[Archegos]] affair. | ||