SOURCE ANALYSIS AND EMPIRICAL STUDY FOR TRACKING ERROR INVOLVING IN THE LEVERAGED ETF - EVIDENCES FROM TAIWAN 50 LEVERAGED ETF

Abstract

Following the international development tendency, leveraged ETFs have also been listed and traded in 2014 in Taiwan. Leveraged ETFs are mainly used for short-term leveraged speculation and hedging trades. Moreover, leveraged ETFs implement the daily rebalancing to achieve the target multiple return. Nevertheless, there is still a certain tracking error and thus results in the real return rate of leveraged ETFs to deviate from their presetting target multiples. Tracking error is mainly generated by the compounding effect and the fact that the ETF price is not synchronized with the price of the underlying asset (non-compounding effect), and this study deeply explores and analyzes the nature and cause structure involving the tracking error for leveraged ETFs. At the same time, this study takes the T50 2X and T50 -1X as the empirical samples, and conducts empirical study for 9 years. Finally, it is empirically found that, overall, the tracking error generated by the compounding effect and non-compounding effect accounts respectively for about 40% and for about 60%. In addition, the price volatility of the underlying asset significantly positively and negatively impacts on the total tracking error and compounding effect tracking error of the T50 2X and T50 -1X, respectively. While, the average daily return rate of the underlying assets has a significant negative and positive impact on the total tracking error and non-compounding effect tracking error, respectively. These empirical findings should have practicable reference value for the leveraged ETFs issuers and managers, and investors.