Are Leveraged and Inverse ETFs the New Portfolio Insurers?
51 Pages Posted: 19 Dec 2012 Last revised: 26 Sep 2014
Date Written: May 28, 2014
Mechanical positive-feedback rebalancing of Leveraged and Inverse Exchange Traded Funds (LETFs) resembles the portfolio insurance strategies, which contributed to the stock market crash of October 19, 1987 (Brady Report, 1988). I show that a 1% increase in stock indexes induces LETFs to originate rebalancing flows equivalent to $1.04 billion worth of stock. Concentrated trading of LETFs results in price reaction and extra volatility. Implied price impact calculations suggest that they contributed to the stock market volatility in the 2008-2009 financial crisis and in the second half of 2011 when the European sovereign debt crisis came to the forefront.
Keywords: ETFs, Price Impact, Financial Stability, Stock Market Crashes
JEL Classification: G10, G23, G01
Suggested Citation: Suggested Citation