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Global Scholars Journal of Banking and International Finance Vol. 2 (1), pp 8-15 October, 2015
©2015 Global Scholars Journals.

 

Full Length Research Paper

Explaining ETF decay

Harlan Platt1*, Licheng Cai2 and Marjorie Platt1

1 Northeastern University, 360 Huntington Ave, Boston, USA.
2 Brown Brothers Harriman, 140 Broadway, New York, USA.

* E-mail: h.platt@neu.edu.

Accepted 17 September, 2015

 

 

   
   
   
   
   
   
   
   
   
   
   
   

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  Abstract  
 

Exchange-traded funds (ETFs) have many advantages relative to mutual funds but certain types experience price decay. Price decay means that the instrument’s price falls while the underlying asset’s price, which it is designed to mirror, remains unchanged. Although this phenomenon is understood by sophisticated investors it is generally unknown to retail investors. The inevitability of the price decay process has never been proven mathematically. This paper provides mathematical proofs of price decay for inverse ETFs and leveraged long and short ETFs. It also identifies a way for investors to achieve inverse or leveraged returns while avoiding price decay.

Key Words: Exchange traded funds, price-decay, leverage, inverse investing.


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