Overpricing and Hidden Costs of Structured Products for Retail Investors: Evidence from the Danish Market for Principal Protected Notes

35 Pages Posted: 13 Jun 2011 Last revised: 19 Jul 2012

Peter Løchte Jørgensen

University of Aarhus - Business and Social Sciences

Henrik Nørholm

University of Aarhus - School of Business and Social Sciences

David Skovmand

University of Aarhus - School of Business and Social Sciences

Date Written: June 13, 2011

Abstract

This paper studies the cost structure and pricing efficiency of principal protected notes (PPNs) from the Danish retail market. Our data set consists of detailed information on almost 400 Danish issues of PPNs during the period from 1998 to 2009. Comparing actual offer prices with theoretical fair values we find that on average PPNs are overpriced by about 6%. While overpricing of structured retail products is well-documented in the literature, our paper is the first to compare the level of overpricing with the product costs disclosed by sellers at issuance. We find that on average only about half of the overpricing can be explained by disclosed product costs. The finding of a significant hidden cost component in structured retail products is new to the literature.

At the individual instrument level we find time to maturity and indicators of product complexity to be important determinants of costs and of the degree of overpricing, but other factors such as arranger and issuer size play a part as well. The degree of overpricing of PPNs has declined over time, but the unexplained cost component - hidden costs - has not.

Keywords: structured products, fair valuation, pricing efficiency, exotic option pricing, cost analysis

JEL Classification: G12, G13

Suggested Citation

Jørgensen, Peter Løchte and Nørholm, Henrik and Skovmand, David, Overpricing and Hidden Costs of Structured Products for Retail Investors: Evidence from the Danish Market for Principal Protected Notes (June 13, 2011). Available at SSRN: https://ssrn.com/abstract=1863854 or http://dx.doi.org/10.2139/ssrn.1863854

Peter Løchte Jørgensen (Contact Author)

University of Aarhus - Business and Social Sciences ( email )

Finance Research Group
Fuglesangs Allé 4
DK-8210 Aarhus, 8210
Denmark
+4587165117 (Phone)

HOME PAGE: http://pure.au.dk/portal/en/plj@econ.au.dk

Henrik Nørholm

University of Aarhus - School of Business and Social Sciences ( email )

Nordre Ringgade 1
Aarhus C, DK-8000
Denmark

David Skovmand

University of Aarhus - School of Business and Social Sciences ( email )

Nordre Ringgade 1
Aarhus C, DK-8000
Denmark

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