Pricing of Bank-Issued Investment Products - Premium Shifts and Investor Wealth

35 Pages Posted: 28 Sep 2012 Last revised: 13 Oct 2013

Felix Fritz

Karlsruhe Institute of Technology

Stephan Meyer

Karlsruhe Institute of Technology

Date Written: December 28, 2012

Abstract

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

Fritz, Felix and Meyer, Stephan, Pricing of Bank-Issued Investment Products - Premium Shifts and Investor Wealth (December 28, 2012). Available at SSRN: https://ssrn.com/abstract=2153723 or http://dx.doi.org/10.2139/ssrn.2153723

Felix Fritz

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

Stephan Meyer (Contact Author)

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

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