Do Leveraged ETFs Induce Volatility on their Underlying Indices? The German Case

Abstract

There is no doubt that Exchanged Traded Funds are an asset class that has gained a paramount importance in the last years. They have lately shown a fast pace of growth and they are an example of a successful innovation as a financial instrument. In order to achieve the promised daily leveraged returns, the Leveraged ETF managers have to rebalance their assets presumably at the end of the day, in order to lever their positions, and manage their exposure on daily basis. The purpose of this work is to assess the impact of this new instrument to the actual market structure and see the microstructure effects on their underlying assets, paying special attention to the LETFs that track the DAX Index. We examine the ownership effects and determine that the underlying DAX stocks see their daily average volatility increased by 10%, after the LETF inception. We also explore the relationship between the rebalancing flows and the underlying end of the day volatility and see that on the interval between 17:00:00 and 17:29:59, the impact of LETF rebalancing is at its highest level and representing approximately the 4% of the average volatility.