Open-End Knock-Outs on Bond Futures: Valuation, Properties and Estimation of Hidden Profit Drivers

47 Pages Posted: 22 Apr 2014

See all articles by Oliver Entrop

Oliver Entrop

University of Passau

Christian Peters

University of Augsburg

Marco Wilkens

University of Augsburg

Date Written: April 21, 2014

Abstract

This paper is the first on retail Structured Financial Products (SFPs) from the fixed-income area, namely open-end knock-outs (OEKOs) on government bond futures. We develop and apply a valuation algorithm for OEKOs to analyze the issuers' profit. On the basis of a simple superhedging strategy we disclose the profit drivers for the issuers. The crucial profit drivers, the 'margin factor' and the 'rollover fee', are set by the issuers and can be regarded directly as costs to the investors. But even disregarding these drivers there exists a 'hidden' interest gain. However, asymmetric jumps in the interest rate dynamics may lead to significant gap risks which can considerably lower the issuers' benefit, even below zero. Since the crucial profit drivers of OEKOs are not directly observable, we estimate them by analyzing an extensive data set of OEKO prices. Inter alia, depending on the issuer we find that the profit drivers can take values of up to 60% p.a. on average.

Keywords: structured products, knock-out, price setting, German market, rollover

JEL Classification: G12, G13, G21, G24

Suggested Citation

Entrop, Oliver and Peters, Christian and Wilkens, Marco, Open-End Knock-Outs on Bond Futures: Valuation, Properties and Estimation of Hidden Profit Drivers (April 21, 2014). Available at SSRN: https://ssrn.com/abstract=2427333 or http://dx.doi.org/10.2139/ssrn.2427333

Oliver Entrop

University of Passau ( email )

Innstrasse 27
Passau, 94032
Germany
+49 851 509 2460 (Phone)
+49 851 509 2462 (Fax)

Christian Peters (Contact Author)

University of Augsburg ( email )

Universitätsstr. 16
Augsburg, 86135
Germany
+49 821 598 4124 (Phone)
+49 821 598 4223 (Fax)

Marco Wilkens

University of Augsburg ( email )

Universitaetsstr. 16
Augsburg, 86159
Germany
+49 821 598 4124 (Phone)
+49 821 598 4223 (Fax)

HOME PAGE: http://www.wiwi.uni-augsburg.de/bwl/wilkens/team/wilkens_marco/

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