Homemade Leverage

Homemade Leverage

A substitution of risks that investors may undergo in order to move from overpriced shares in highly levered firms to those in unlevered firms by borrowing in personal accounts.

Notes:

Mainly attributed to the Modigliani-Miller Theorem, homemade leverage describes the situation where individuals borrowing on the exact same terms as large firms can duplicate corporate leverage through purchasing and financing options.

See also: Leverage, Modigliani-Miller Theorem

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Homemade leverage

Idea that as long as individuals borrow (or lend) on the same terms as the firm, they can duplicate the effects of corporate leverage on their own. Thus, if levered firms are priced too high, rational investors will simply borrow on personal accounts to buy shares in unlevered firms.