Optimum Leverage Level of the Banking Sector

Date of Award


Degree Name

Doctor of Philosophy



First Advisor

Dr. Qiji J. Zhu

Second Advisor

Dr. Pedro Judice

Third Advisor

Dr. Yuri S. Ledyaev

Fourth Advisor

Dr. Jay S. Treiman


leverage level, growth optimal portfolio, asset liability management, long-term risk, interest rate risk credit risk


Banks make profits from the difference between short-term and long-term interest rates. To issue loans, banks raise funds from capital markets. Since the long-term loan rate is relatively stable, but short-term interest is usually variable, there is an interest rate risk. Therefore, banks need information about the optimal leverage strategies based on the current economic situation. The recent studies of the economic crisis by many economists showed that it was due to too much leveraging by "big banks." That leveraging turns out to be close to Kelly's Optimal point. Since Kelly's strategy does not address risk adequately, in addition we use the Return-Drawdown ratio and inflection point of Kelly's cumulative returns and analyze the three leverage levels alluded to above with the best fitted distribution of the returns with historical data. We then carry out a sensitivity analysis to determine strategies during a period of interest rates increase, which is the most important and risky period to leverage. Thereafter, we consider two types of loans together and examine the derivatives of the three points mentioned above with respect to the allocation sizes of each loan type to determine how much and how quickly to change leverage or allocation sizes when interest rates increase. This provides bank managers flexible tools in mitigating risk.

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