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Leveraged Exchange-Traded Funds with Market Closure and Frictions

Author

Listed:
  • 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)

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.

Suggested Citation

  • Min Dai & Steven Kou & H. Mete Soner & Chen Yang, 2023. "Leveraged Exchange-Traded Funds with Market Closure and Frictions," Management Science, INFORMS, vol. 69(4), pages 2517-2535, April.
    • Handle: RePEc:inm:ormnsc:v:69:y:2023:i:4:p:2517-2535
    DOI: 10.1287/mnsc.2022.4407
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    References listed on IDEAS

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