Are Leveraged and Inverse ETFs the New Portfolio Insurers?

51 Pages Posted: 19 Dec 2012 Last revised: 26 Sep 2014

Multiple version iconThere are 2 versions of this paper

Date Written: May 28, 2014

Abstract

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

Tuzun, Tugkan, Are Leveraged and Inverse ETFs the New Portfolio Insurers? (May 28, 2014). Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper. Available at SSRN: https://ssrn.com/abstract=2190708 or http://dx.doi.org/10.2139/ssrn.2190708

Tugkan Tuzun (Contact Author)

Federal Reserve Board ( email )

DC 20551
United States

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