Leveraged Exchange Traded Funds and Volatility: An Exploratory Discussion

Golden, William, Systems Engineering - School of Engineering and Applied Science, University of Virginia
Scherer, William, Department of Systems and Information Engineering, University of Virginia

In the late 1980’s, futures trading was at the center of every market analyst’s mind; surely the remarkable spike in market volatility had to be related to this new investment tool. Over twenty years later, another marked increase in volatility has coincided with the use of a revolutionary investment tool: leveraged exchange traded funds. These investment vehicles, first released in 2006, seek to make multiples or multiple inverses of a given index or commodity. For example, a 2X leveraged exchange traded fund tracking the S&P 500 promises to double the performance of that index over a given time period. However, there has been much confusion about the manner in which they are leveraged, the advertised multiple they seek to attain, and how their daily rebalancing influences market volatility.
This research will consider the volatility of leveraged exchange traded funds on intra-day and inter-day intervals. Utilizing different methods of correlation considerations, different leveraged exchanged traded funds and indexes will be considered and their link to widespread volatility studied. Due to the nature of their structure, leveraged exchange traded funds inherently experience increased volatility at certain points throughout the trading day; this paper will investigate the manner in which the volatility demonstrated by leveraged exchange traded funds influences and alters index and market wide volatility trends.

MS (Master of Science)
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