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Leverage Certificates - A Case of Innovative Financial Engineering

Author

Listed:
  • Rodrigo Hernandez

    (Radford University, 274 Kyle Hall, Radford, VA 24142, U.S.A.)

  • Yingying Shao

    (Towson University, 316F Stephens Hall, Towson, MD 21252, U.S.A.)

  • Pu Liu

    (Harold A. Dulan Chair Professor in Capital Formation; Robert E. Kennedy Chair Professor in Investment, University of Arkansas, 302B Business Building, Fayetteville, AR 72701, U.S.A.)

Abstract

This paper introduces a new financial product named Leverage Certificates and provides detailed descriptions of the product specifications. We show that the payoff of a Leverage Certificate can be duplicated with a portfolio of securities (i.e. bonds, plain vanilla options and exotic options). A pricing formula is developed to price the certificates. A certificate issued by Credit Suisse First Boston is presented as an example to examine how well the model fits empirical data. The results show that issuing Leverage Certificates is a profitable business and the results are in line with previous studies pricing other structured products.

Suggested Citation

  • Rodrigo Hernandez & Yingying Shao & Pu Liu, 2017. "Leverage Certificates - A Case of Innovative Financial Engineering," Review of Economics & Finance, Better Advances Press, Canada, vol. 9, pages 71-82, August.
    • Handle: RePEc:bap:journl:170306
    Note: Authors are thankful for the suggestions from the participants at the 20th PBFEAM Conference, the 2012 FMA Annual Meeting, the 2012 SFA Annual Conference, the 2013 Universidad Aut¨®noma de Yucatan Research Conference, and the 2017 AEF Annual Meeting. Funding for the research was provided by Harold A. Dulan Professorship for Capital Formation and Robert E. Kennedy Chair for Investment.
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    References listed on IDEAS

    as
    1. Peter A. Abken, 1989. "A survey and analysis of index-linked certificates of deposit," FRB Atlanta Working Paper 89-1, Federal Reserve Bank of Atlanta.
    2. Stoimenov, Pavel A. & Wilkens, Sascha, 2005. "Are structured products 'fairly' priced? An analysis of the German market for equity-linked instruments," Journal of Banking & Finance, Elsevier, vol. 29(12), pages 2971-2993, December.
    3. Rodrigo Hernández & Wayne Lee & Pu Liu & Tian-Shyr Dai, 2013. "Outperformance Certificates: analysis, pricing, interpretation, and performance," Review of Quantitative Finance and Accounting, Springer, vol. 40(4), pages 691-713, May.
    4. Andreas Grünbichler & Hanspeter Wohlwend, 2005. "The Valuation of Structured Products: Empirical Findings for the Swiss Market," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 19(4), pages 361-380, December.
    5. Benet, Bruce A. & Giannetti, Antoine & Pissaris, Seema, 2006. "Gains from structured product markets: The case of reverse-exchangeable securities (RES)," Journal of Banking & Finance, Elsevier, vol. 30(1), pages 111-132, January.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Leverage Certificates; Outperformance Certificates; Reverse Exchangeable Bonds; Option pricing; Structured products; Financial innovation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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