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Hedge ratios for short and leveraged ETFs

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  • Leo Schubert

    (Constance University of Applied Sciences. Germany.)

Abstract

Exchange-traded funds (ETFs) exist for stock, bond and commodity markets. In most cases the underlying feature of an ETF is an index. Fund management today uses the active and the passive way to construct a portfolio. ETFs can be used for passive portfolio management, for which ETFs with positive leverage factors are preferred. In the frame of an active portfolio management the ETFs with negative leverage factors can also be applied for the hedge or cross hedge of a portfolio. These hedging possibilities will be analysed in this paper. Short ETFs exist with different leverage factors. In Europe, the leverage factors 1 (e.g. ShortDAX ETF) and 2 (e.g. DJ STOXX 600 Double Short) are offered while in the financial markets of the United States factors from 1 to 4 can be found. To investigate the effect of the different leverage factors and other parameters Monte Carlo simulation was used. The results show for example that higher leverage factors achieve higher profits as well as losses. In the case that a bearish market is supposed, minimizing the variance of the hedge seems not to obtain better hedging results, due to a very skewed return distribution of the hedge. The risk measure target-shortfall probability confirms the use of the standard hedge weightings, which depend only on the leverage factor. This characteristic remains when a portfolio has to be hedged instead of the underlying index of the short ETF. For portfolios that have a low correlation with the index return high leverage factors should not be used for hedging, due to the higher volatility and target-shortfall probability.

Suggested Citation

  • Leo Schubert, 2011. "Hedge ratios for short and leveraged ETFs," Economic Analysis Working Papers (2002-2010). Atlantic Review of Economics (2011-2016), Colexio de Economistas de A Coruña, Spain and Fundación Una Galicia Moderna, vol. 1, pages 1-1, June.
    • Handle: RePEc:eac:articl:03/10
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    References listed on IDEAS

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    1. Thorsten Michalik & Leo Schubert, 2009. "Hedging Portfolios with Short ETFs," Economic Analysis Working Papers (2002-2010). Atlantic Review of Economics (2011-2016), Colexio de Economistas de A Coruña, Spain and Fundación Una Galicia Moderna, vol. 8, pages 1-23, December.
    2. Carol Alexander & Andreza Barbosa, 2007. "Hedging and Cross-hedging ETFs," ICMA Centre Discussion Papers in Finance icma-dp2007-01, Henley Business School, University of Reading.
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