Hedging Costs and Joint Determinants of Premiums and Spreads in Structured Financial Products

48 Pages Posted: 29 Oct 2018

See all articles by Oliver Entrop

Oliver Entrop

University of Passau

Georg Fischer

University of Passau

Date Written: October 1, 2018

Abstract

This paper is the first to analyze the joint determinants of premiums and spreads in structured financial products, while also focusing on issuers’ hedging costs. We evaluate more than 396,000 single stock discount certificates on an intraday basis in the German secondary market. We find that premiums and spreads are endogenous and negatively related to each other, and depend on different key determinants. The economically significant determinants of the premiums are mainly profit-related, i.e. dividends of the underlying, issuers’ credit risk, lifecycle effect and competition, whereas hedging costs and risks are economically less important. However, initial hedging costs are also priced into the premium in the case of large inventory changes. The spread is mostly determined by hedging costs and risk components, such as initial hedging costs, rebalancing costs, volatility, scalper risk, and overnight gap risk, but also depends on dividends. Initial hedging costs appear to be more relevant than rebalancing costs.

Keywords: Discount Certificates, Derivatives, Pricing, Market Microstructure, Trading Costs, Hedging

JEL Classification: D40, G12, G21

Suggested Citation

Entrop, Oliver and Fischer, Georg, Hedging Costs and Joint Determinants of Premiums and Spreads in Structured Financial Products (October 1, 2018). Available at SSRN: https://ssrn.com/abstract=3259786 or http://dx.doi.org/10.2139/ssrn.3259786

Oliver Entrop (Contact Author)

University of Passau ( email )

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

Georg Fischer

University of Passau ( email )

Innstrasse 27
Passau, 94032
Germany

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