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Abstract
In this article, we study leveraged ETFs, in particular, Ultra ETFs and Ultrashort ETFs from the ProShares family. These Ultra (Ultrashort) ETFs are designed to provide twice (twice the opposite) of the performance of the benchmark on a daily basis. We focus on the relation between long term performance of leveraged ETFs and benchmarks. Our results show that over holding periods no greater than one month, an investor can safely assume that the Ultra (Ultrashort) ETF would provide twice the return (twice the negative return) of the underlying benchmark. Over the holding period of one quarter, the Ultrashort ETFs can deviate from twice the negative returns of the benchmark. For Ultra ETFs, this deviation occurs when the holding period is one year. Finally, we show that the long term performance of the leveraged ETFs is negatively impacted by the quadratic variation and the auto-variation during the period, with auto-variation being the more dominant factor. © 2012 Academy of Financial Services. All rights reserved.
JEL classifications: G1
Keywords: Leveraged ETFs; Bootstrapping
(ProQuest: ... denotes formulae omitted.)
1. Introduction
Leveraged Exchange Traded Funds (ETFs) are designed to provide more than 100% of the exposure of the benchmark. Since July 2006, ProShares has launched a series of Ultra ETFs and Ultrashort ETFs. The Ultra ETFs are designed to double the daily returns of the underlying index while the Ultrashort ETFs are designed to provide twice the inverse performance of the underlying index on a daily basis. These leveraged ETFs become popular trading instruments and their daily trading volumes are quite high.1 In November 2008, Direxion even introduces triple leveraged ETFs and these triple ETFs immediately gain acceptance from the market.
Given the large trading volumes of these leveraged ETFs, it is tempting to use them as part of the investment portfolio. While the focus of these ETFs is to double or triple the daily movement of the benchmark, for a long term investor, it is crucial to understand the long term performance of these leveraged ETFs. Do they deliver the same times of the long term performance of the benchmark? If the answer is yes, then an investor may gain the same long term exposure as holding the benchmark by holding a small amount of...