Pricing of Bank-Issued Investment Products - Premium Shifts and Investor Wealth
35 Pages Posted: 28 Sep 2012 Last revised: 13 Oct 2013
Date Written: December 28, 2012
We study the intraday pricing of exchange traded bank-issued financial products in Germany. We decompose traded prices into two parts; (1) the theoretical value; and (2) the product premium. We find, consistent with the previous literature, positive premiums that suggest issuers are earning risk-free profits. We focus on premium shifts during the trading day and explore two competing but not mutually exclusive explanations. The first explanation is that issuers adjust their premiums throughout the trading day to reflect the risk associated with their dynamic hedging strategies. The second explanation is that issuers adjust their premiums based on the demand for their products. We find support for both explanations. Finally we quantify the losses suffered by retail investors by buying at periods when premiums are high and selling them when they are low. We find that the losses incurred by holding bank-issued products is an order of magnitude greater than losses incurred due to poorly timed trades during the trading day.
Keywords: Retail Investors, Option Pricing, Bank-issued Products, Barrier Options
JEL Classification: G10, G14
Suggested Citation: Suggested Citation