A dynamic model for leveraged funds

Guido Giese derives a model for the performance and Sharpe ratio of leveraged and inverse index funds that follow a dynamic leveraged trading strategy, that is, they are rebalanced on a daily basis to ensure a constant degree of leverage with respect to the underlying. He shows that the performance behaviour produces a trade-off between exploiting higher growth rates due to leverage and performance losses due to the volatility of the underlying. As a consequence, he finds that there is an optimal degree of leverage that is supported by numerical simulations

Leveraged investment products have become a widely used asset class in both the derivatives market and the exchange-traded fund (ETF) market (see Edhec, 2009). With the recent financial turmoil, ETFs have become increasingly popular in comparison with derivatives structured products, in particular long and short leveraged ETFs, which offer a different type of leverage strategy compared with certificates. In simple terms, leveraged certificates such as mini-futures typically offer a leverage

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