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Understanding the risk of leveraged ETFs

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  • Jarrow, Robert A.

Abstract

The purpose of this paper is to clarify the risks of leveraged ETFs. We do this by showing how to construct a k-times leveraged ETF as a dynamic portfolio in the ETF and a money market account. This construction characterizes the return distribution of the leveraged ETF over any investment horizon. As a corollary, we show that a k-times leveraged ETF will not earn k times the return of the ETF. It differs due to a term involving the ETF's volatility and the interest paid on the borrowing over the investment horizon.

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Bibliographic Info

Article provided by Elsevier in its journal Finance Research Letters.

Volume (Year): 7 (2010)
Issue (Month): 3 (September)
Pages: 135-139

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Handle: RePEc:eee:finlet:v:7:y:2010:i:3:p:135-139

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Web page: http://www.elsevier.com/locate/frl

Related research

Keywords: Leveraged ETFs Inverse ETFs Dynamic portfolio construction;

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Cited by:
  1. Bell, Peter N, 2010. "Beta estimates for leveraged ETF," MPRA Paper 26950, University Library of Munich, Germany.
  2. Andrea Frazzini & Lasse H. Pedersen, 2012. "Embedded Leverage," NBER Working Papers 18558, National Bureau of Economic Research, Inc.
  3. Tim Leung & Qingshuo Song & Jie Yang, 2013. "Outperformance portfolio optimization via the equivalence of pure and randomized hypothesis testing," Finance and Stochastics, Springer, vol. 17(4), pages 839-870, October.
  4. Tugkan Tuzun, 2013. "Are leveraged and inverse ETFs the new portfolio insurers?," Finance and Economics Discussion Series 2013-48, Board of Governors of the Federal Reserve System (U.S.).
  5. Charupat, Narat & Miu, Peter, 2011. "The pricing and performance of leveraged exchange-traded funds," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 966-977, April.
  6. Jason Scott & John Watson, 2013. "The Floor-Leverage Rule for Retirement," Discussion Papers 13-013, Stanford Institute for Economic Policy Research.
  7. Li, Mingsheng & Zhao, Xin, 2014. "Impact of leveraged ETF trading on the market quality of component stocks," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 90-108.

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