Archimedes reportedly said, “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” The Greek mathematician was one of the first people to fully recognize the immense power of leverage. He also recognized the risk of excessive leverage, stating that it could literally throw the earth off its course. As in mechanical systems, well-deployed financial leverage can greatly enhance performance. However, excessive leverage can be ruinous.
Risk leverage defines the sensitivity of the returns in a portfolio construction to those of the underlying market. If you remember your high school physics, ...