Statistical Methods in Finance 2017

Abstract

Same Leverage, Less Volatility: A Statistical Approach to the Construction of Leveraged Funds

by Ravindra Khattree

Leveraged exchange traded funds (LETF) are very recent and extremely successful financial innovations in the financial industry. A leveraged exchange-traded fund is a publicly traded financial instrument whose goal is to generate daily returns that are a chosen multiple (say twice or thrice) of the daily returns on some benchmark index. This in turn also makes the leveraged fund considerably more volatile than the benchmark. To add to this discomfort and as surprising as it may sound, in long term, the compounded returns of leveraged fund may even not be of the order of that chosen multiple. In this presentation, we will first review the mechanics and dynamics of the leveraged exchanged traded funds and then explore the statistical aspects of the movement of leveraged exchange traded funds. We then devise a strategy and hence design a leveraged fund, whose performance in terms of volatility and uncertainly is better than the leveraged exchange traded funds described above.

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