Unraveling the Leverage Exchange-Traded Funds Conundrum

Abstract

This thesis examines Leveraged Exchange-Traded Funds to assess their ability to deliver the promised leverage, factor anomalies, behavior in different market conditions, long-term performance drivers, and pricing efficiency. Findings reveal that LETFs consistently underdeliver on promised leverage, with investors paying a premium for access to leverage. Systematic factor mispricing is observed, and LETFs exhibit significant tracking errors. Shorting LETFs proves profitable in ordinary market conditions. Pricing inefficiencies are larger in LETFs than unleveraged ETFs and are influenced by benchmark movements. LETFs pose challenges encompassing tracking errors, compounding effects, and volatility decay, making them unsuitable for long-term investment. Regulatory considerations and investor awareness are crucial for the healthy functioning of financial markets.