Understanding the risk of leveraged ETFs |
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| Authors: | Robert A. Jarrow |
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| Affiliation: | 1. University of Orléans, Laboratoire d’Economie d’Orléans, Rue de Blois, 45067 Orléans, France;2. HEC Paris, 1 Avenue de la libération, Jouy en Josas, France;3. Canadian Imperial Bank of Commerce, 161 Bay Street, Toronto, Canada;1. St. John''s University, Queens, NY, United States;2. Marshall Management Services, Long Island, NY, United States |
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| 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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