Academic Scholarship

Solving the Return Deviation Conundrum of Leveraged Exchange-traded Funds

Journal of Financial and Quantitative Analysis, Volume 48, Issue 1, 309-342, February 2013

JFQA Hongfei Frank Tang, Ph.D.
Department of Finance
Xiaoqing Eleanor Xu, Ph.D., CFA
Department of Finance

The large deviation of the actual return of a Leveraged Exchange-Traded Fund (LETF) from the leveraged multiple of the underlying index return has drawn considerable attention from investors, regulators and the financial media. Despite this attention, the sources and fundamental determinants of the LETF return deviation remain unidentified. This study constructs a clear, unified, objective and executable framework that addresses the behaviors, sources and determinants of the LETF compounding and non-compounding deviations. Our theoretical predictions and empirical results hold the promise of guiding investors, regulators, financial advisors and portfolio managers toward a thorough understanding of the return behavior of LETFs.


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