The leverage cycle in finance refers to the phenomenon where the level of leverage (the use of borrowed funds to increase investment) fluctuates in response to changing economic conditions and investor sentiment. During periods of economic expansion, firms and investors often increase their leverage in pursuit of higher returns, leading to a credit boom. Conversely, when economic conditions deteriorate, the perception of risk increases, prompting a deleveraging phase where entities reduce their debt levels to stabilize their finances. This cycle can create significant volatility in financial markets, as increased leverage amplifies both potential gains and losses. Ultimately, the leverage cycle illustrates the interconnectedness of credit markets, investment behavior, and broader economic conditions, emphasizing the importance of managing risk effectively throughout different phases of the cycle.
Start your personalized study experience with acemate today. Sign up for free and find summaries and mock exams for your university.