Leveraged Exchange-Traded Funds with Market Closure and Frictions

Min Dai (), Steven Kou (), H. Mete Soner () and Chen Yang ()
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Min Dai: Department of Applied Mathematics, The Hong Kong Polytechnic University, Kowloon, Hong Kong
Steven Kou: Questrom School of Business, Boston University, Boston, Massachusetts 02215
H. Mete Soner: Department of Operations Research and Financial Engineering, Princeton University, Princeton, New Jersey 08540
Chen Yang: Department of Systems Engineering and Engineering Management, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong

Management Science, 2023, vol. 69, issue 4, 2517-2535

Abstract: Although leveraged exchange-traded funds (ETFs) are popular products for retail investors, how to hedge them poses a great challenge to financial institutions. We develop an optimal rebalancing (hedging) model for leveraged ETFs in a comprehensive setting, including overnight market closure and market frictions. The model allows for an analytical optimal rebalancing strategy. The result extends the principle of “aiming in front of target” introduced by Gârleanu and Pedersen (2013) from a constant weight between current and future positions to a time-varying weight because the rebalancing performance is monitored only at discrete time points, but the rebalancing takes place continuously. Empirical findings and implications for the weekend effect and the intraday trading volume are also presented.

Keywords: daily rebalancing; leveraged ETFs; market closure; frictions (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:69:y:2023:i:4:p:2517-2535

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