Leveraged Funds: Robust Replication and Performance Evaluation

32 Pages Posted: 19 Sep 2016 Last revised: 21 Feb 2019

See all articles by Paolo Guasoni

Paolo Guasoni

Dublin City University - School of Mathematical Sciences; Boston University - Department of Mathematics and Statistics

Eberhard Mayerhofer

University of Limerick - Department of Mathematics and Statistics

Date Written: March 1, 2017

Abstract

Leveraged and inverse exchange-traded funds seek daily returns equal to fixed multiples of indexes' returns. Trading costs implied by frequent adjustments of funds' portfolios create a tension between tracking error, reflecting short-term correlation with the index, and excess return, the long-term deviation from the leveraged index' performance. With proportional costs, the optimal replication policy is robust to the index' dynamics. Overall fund performance is summarized by the implied spread, the product of tracking error and excess return, rescaled for leverage and volatility. The implied spread is insensitive to risk-premia and enables comparisons of funds tracking different factors of an index.

Keywords: transaction costs, performance evaluation, tracking error, leverage, ETFs

JEL Classification: G11, G23

Suggested Citation

Guasoni, Paolo and Mayerhofer, Eberhard, Leveraged Funds: Robust Replication and Performance Evaluation (March 1, 2017). Michael J. Brennan Irish Finance Working Paper Series Research Paper No. 19-1, Available at SSRN: https://ssrn.com/abstract=2839852 or http://dx.doi.org/10.2139/ssrn.2839852

Paolo Guasoni (Contact Author)

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

HOME PAGE: http://www.guasoni.com

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Eberhard Mayerhofer

University of Limerick - Department of Mathematics and Statistics ( email )

Castletroy, Co
Limerick
Ireland

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