The necessity to activate long-term ETD in Korea

Hyoseob Lee

doi:10.1108/jdqs-08-2020-0020

Abstract

Purpose This paper aims to provide the necessity to activate long-term exchange-traded derivatives (ETD) in Korea. In the era of aging, low interest rates and low economic growth, the investment demand for long-term financial products, and its hedging demand have steadily increased. Unfortunately, long-term ETD do not trade in Korea, and this study presents political suggestions to invigorate long-term ETD based on overseas cases and empirical analysis. Specifically, this study suggests the necessity to activate exchange traded funds (ETFs) options, long-term Korea treasury bond futures and options and long-term Volatility Index of Korea Composite Stock Price Index future and options. The introduction of those long-term ETD not only contributes to providing long-term investment and hedging vehicles but also reduces market inefficiencies in the Korean industry of ETFs, bonds and structured products.

Highlights

Global exchange-traded derivatives (ETD) market has steadily grown [1]
As a result of the ordinary linear regression by controlling the index return and the change of volatility index, we found that the increase in equity-linked securities (ELS) outstanding amount significantly reduced the Volatility Index of KOSPI (VKOSPI) index relative to the VIX index, which caused the undervaluation of the Korean equity index’s option market
Unlike the exchange-traded note (ETN), retail structured products and closed-end mutual funds, exchange traded funds (ETFs) have an infinite maturity and ETF options can be classified as the long-term ETD

Summary

Introduction

Global exchange-traded derivatives (ETD) market has steadily grown [1]. As you can see in Figure 1, the number of global ETD contracts in 2019 reached 34.5 billion, which was increased by 122.6% from 2007 (compound annual growth rate [CAGR] is 7%). As the low interest rates and low economic growth continues, long-term investment products such as ETF, equity-linked securities (ELS) and long-term government bonds have traded actively. Institutional investors such as Korean insurance companies, commercial banks and some pension funds have already increased their investments on ETFs and long-term government bonds. Kim et al (2018a) analyzed cross-sectional ETF data and found that trading volume and institutional investors’ participation ratio affected negative discrepancy of ETFs These papers mainly focused on KOSPI200 ETFs and found that the lower the liquidity, the lower the proportion of institutional investors, and the greater the volatility, the higher the discrepancy ratio between ETFs’ NAV and market value. AUM AUM ratio [(A)/ Average daily Trading ratio [(B)/ Turn over Rank ETF product name (A) total AUM] (%) trading amount (B) total trading] (%) (B/A) (%)

TIGER200

Findings

Conclusion