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Who should buy structured investment products and why?

Author

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  • Massimo Guidolin
  • Giacomo Leonetti
  • Manuela Pedio

Abstract

Structured products in general, and investment certificates in particular, have gained increasing popularity among retail investors over the last decade, both in Europe and in the US. However, based on data on the ex-post realized gains of retail clients investing in certificates, the literature has generally concluded that the high demand of these products may be hard to rationalize within a portfolio optimization framework. In this paper, we investigate whether a rational, perfectly informed investor with standard constant relative risk aversion (CRRA) preferences who optimally allocates her wealth among risky and riskless assets can ex-ante expect to benefit from adding structured products to her portfolio. We show that the utility gains from investment certificates vary dramatically across alternative structures, investment horizons and levels of risk aversion. Therefore, a correct assessment of an investors’ risk tolerance and investment horizon is crucial when advising on the relevance of structured products. We also find that the optimal demand of investment certificates as well as their benefits depend heavily on the pricing model informing the portfolio assessment and that demand is considerably higher when the joint presence of jumps in returns and volatility were to go undetected. Therefore, the high demand of structured products can be explained by the use of asset pricing models that are excessively simplistic and ignore discontinuous dynamics.

Suggested Citation

  • Massimo Guidolin & Giacomo Leonetti & Manuela Pedio, 2024. "Who should buy structured investment products and why?," BAFFI CAREFIN Working Papers 24222, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    • Handle: RePEc:baf:cbafwp:cbafwp24222
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