On the nature of financial leverage

TL;DR

This paper reinterprets financial leverage through decision theory, introducing new metrics like see-through-leverage to better understand economic crises and emphasizing the importance of statistical regularities and decision maker rationality.

Contribution

It offers a novel decision-theoretic perspective on financial leverage and introduces metrics that enhance understanding of economic crises.

Findings

See-through-leverage metrics aid in understanding crises

Decision theory perspective clarifies financial leverage concepts

Statistical regularities influence decision-making in finance

Abstract

The article presents a translation of some widespread financial terminology into the language of decision theory. For instance, financial leverage can be regarded as an object of choice or a decision. We show how the optics of decision theory allows perceiving the recently introduced metrics of see-through-leverage, which proved to be very useful in understanding the phenomenology of the recent economic crisis. The importance for practical decision making of specification of the statistical regularity of the random phenomena at hand as well as of the rationality class of the decision maker is discussed.