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    Simulation of Leveraged ETF Volatility Using Nonparametric Density Estimation

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    Author
    Ginley, Matthew; Scott, David W.; Ensor, Katherine E.
    Date
    2015
    Abstract
    Leveraged Exchange Traded Funds (LETFs) are constructed to provide the indicated leverage multiple of the daily total return on an underlying index. LETFs may perform as expected on a daily basis; however, fund issuers state that there is no guarantee of achieving the multiple of the index return over longer time horizons. LETF returns are extremely volatile and funds frequently underperform their target for horizons greater than one month. In this paper, we contribute two nonparametric simulation methods for analyzing LETF return volatility and how this is related to the underlying index. First, to overcome the limited history of LETF returns data, we propose a method for simulating implied LETF tracking errors while still accounting for their dependence on underlying index returns. This allows for the incorporation of the complete history of index returns in an LETF returns model. Second, to isolate the effects of daily, leveraged compounding on LETF volatility, we propose an innovative method for simulating daily index returns with a chosen constraint on the multi-day period return. By controlling for the performance of the underlying index, the range of volatilities observed in a simulated sample can be attributed to compounding with leverage and the presence of tracking errors. Our nonparametric methods are flexible-easily incorporating any chosen number of days, leverage ratios, or period return constraints, and can be used in combination or separately to model any quantity of interest derived from daily LETF returns.
    Citation
    Ginley, Matthew, Scott, David W. and Ensor, Katherine E.. "Simulation of Leveraged ETF Volatility Using Nonparametric Density Estimation." Journal of Mathematical Finance, 5, (2015) Scientific Research Publishing: 457-479. http://dx.doi.org/10.4236/jmf.2015.55039.
    Published Version
    http://dx.doi.org/10.4236/jmf.2015.55039
    Keyword
    nonparametric density estimation; exchange traded fund; realized volatility
    Type
    Journal article
    Publisher
    Scientific Research Publishing
    Citable link to this page
    https://hdl.handle.net/1911/87462
    Rights
    This work is licensed under the Creative Commons Attribution International License (CC BY).
    Link to License
    http://creativecommons.org/licenses/by/4.0/
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    • Faculty Publications [4918]
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    Home | FAQ | Contact Us | Privacy Notice | Accessibility Statement
    Managed by the Digital Scholarship Services at Fondren Library, Rice University
    Physical Address: 6100 Main Street, Houston, Texas 77005
    Mailing Address: MS-44, P.O.BOX 1892, Houston, Texas 77251-1892
    Site Map