Bad news bears: Effects of expected market volatility on daily tracking error of leveraged bull and bear ETFs

Abstract

Purpose

This study aims to look into how volatility significantly impacts the tracking error for daily-rebalanced leveraged bull and bear ETFs.

Design/methodology/approach

Using Morningstar return data and Chicago Board Options Exchange (CBOE) volatility index (VIX) data, the paper examines the daily tracking error for leveraged bull and bear ETFs. Tracking error is defined as the difference between the daily returns for a leveraged bull or bear ETF and the multiple of the daily return for that ETF's respective underlying benchmark index.

Findings

Changes in the market VIX of the CBOE have a significant and opposite effect on the daily returns for both leveraged bull and bear ETFs. Furthermore, these effects are more pronounced for bear ETFs than similarly leveraged bull ETFs.

Research limitations/implications

The sample period (June 19, 2006 to September 22, 2009) contains periods of extraordinarily high volatility. Considering that the VIX reached an all-time high during this period, the results may be time-period specific and may not translate to other time periods.

Practical implications

The implication is that market timing may be feasible for enhancing daily returns for both leveraged bull and bear ETFs. However, any specific timing strategies go beyond the scope of this paper.

Originality/value

In this study, the paper examined the effects of expected market volatility on the daily tracking error of leveraged bull and bear ETFs. Specifically, the paper performed multiple linear regression analysis using Morningstar return data for the ETFs and their underlying benchmark and CBOE VIX data. The findings suggest that market timing could be beneficial for increasing daily yields for leveraged and inverse ETFs.

Citation

Matthew Holzhauer, H., Lu, X., W. McLeod, R. and Mehran, J. (2013), "Bad news bears: Effects of expected market volatility on daily tracking error of leveraged bull and bear ETFs", Managerial Finance, Vol. 39 No. 12, pp. 1169-1187. https://doi.org/10.1108/MF-09-2012-0203