Implications of Spillover and Asymmetric Volatility Effects of Leveraged and Inverse Leveraged Exchanged Traded Funds (ETFS) in the Pre- and During Covid-19 Period

Research by: John Francis T. Diaz

EXECUTIVE SUMMARY

This research studies the dynamics of leveraged and inverse leveraged Exchange-Traded Funds (ETFs) within the equities market. Utilizing Exponential General Autoregressive Conditional Heteroskedasticity-Autoregressive Moving Average (EGARCH-ARMA) models, the study explores spillover and leverage effects, and their significance and potential impact on market dynamics. The primary focus is on a specific group of nineteen (19) ETFs, comprising of ten (10) leveraged and nine (9) inverse leveraged ETFs, and their trading connections with corresponding stock indices. Leveraged and inverse leveraged ETFs have gained attention as potential hedging instruments during periods of heightened market volatility. Earlier studies analyzed the differences in liquidity and volatility characteristics among different types of leveraged ETFs. Findings suggest that leveraged ETFs exhibit wider spreads and lower depth, particularly during high volatility periods.

The analysis, conducted against the backdrop of the COVID-19 pandemic, investigates the behavior of these specialized financial instruments during a period marked by heightened market volatility. The findings reveal nuanced relationships, demonstrating spillover effects of returns and volatilities between leveraged ETFs and their associated indices. Importantly, the study highlights the unique ability of these ETFs to amplify both positive and negative market news, positioning them as valuable tools for traders and risk management.

The research also finds asymmetry in the response of stock market indices and ETFs to positive and negative news. Leveraged and inverse leveraged ETFs demonstrate the potential to serve as hedges during market declines, given their ability to move inversely to their respective indices. The study underscores the importance of understanding the intricate interplay between these financial instruments and broader market conditions.

Despite the valuable insights gained, it is crucial to acknowledge the limitations of the study, including its reliance on historical data and the specific timeframe tied to the COVID-19 pandemic. Future research opportunities are identified, urging exploration of longer periods, diverse events, alternative models, and extension of analysis to various asset classes beyond equities.

The study’s implications extend to practical considerations for investors, traders, and fund managers. Leveraged and inverse leveraged ETFs, with their distinct characteristics, offer unique opportunities for portfolio construction, risk management, and capitalizing on bidirectional relationships. The research suggests that these instruments respond more strongly to negative news, indicating potential strategies for navigating specific market conditions effectively.

As a foundation for future research, this study encourages further exploration of leveraged and inverse leveraged ETFs across diverse market conditions and events. Future studies are proposed to investigate risk management strategies, regulatory implications, and recommendations for incorporating these instruments into portfolios. The aim is to enrich our understanding of their adaptability and performance while providing tools and insights for stakeholders to navigate the evolving landscape of financial markets.

This research contributes valuable insights into the complex interplay between leveraged and inverse leveraged ETFs and their tracked indices, particularly in the context of the COVID-19 pandemic. The findings set the stage for future studies that will continue to enhance our knowledge, empowering stakeholders to make informed decisions in the ever-evolving financial landscape.

To cite this article:  Diaz, J. F. T. (2024). Implications of spillover and asymmetric volatility Effects of Leveraged and Inverse Leveraged Exchange Traded Funds (ETFs) in the pre- and during COVID-19 period. International Review of Accounting, Banking and Finance, 16(1), 18-34.

To access this article: http://www.irabf.org/upload/journal/prog/2.%20%20Implications%20of%20Spillover%20and%20Asymmetric%20Volatility%20Effects%20of%20Leveraged%20and%20Inverse%20Leveraged%20ETFs%20-%202.pdf

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