Are structured products ‘fairly’ priced? An analysis of the German market for equity-linked instruments

Stoimenov, Pavel A.; Wilkens, Sascha

doi:10.1016/j.jbankfin.2004.11.001

“…Three studies on the pricing differences between products find a positive relationship between complexity and overpricing: Grünbichler and Wohlwend (2005) for Switzerland, Stoimenov and Wilkens (2005) for Germany and Hernandez et al (2007) for an international sample. Stoimenov and Wilkens (2005) and Hernandez et al (2007) report average premiums of 4.77% and 5.40% for barrier products, for instance, while simpler products trade at a premium of about 3%.…”

Section: Literature Reviewmentioning

confidence: 98%

Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Wallmeier

¹

,

Diethelm

²

2008

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The market for structured financial products in Switzerland ranks among the largest in the world. A unique characteristic of the Swiss market is that its most successful products are reverse convertibles on multiple assets with conditional capital protection (multiple barrier reverse convertibles, MBRC). In other countries, an active market only exists for simpler types of reverse convertibles. The valuation of MBRCs is not straightforward, and pricing tools are not yet publicly available. Thus, transparency with respect to fair values might be poor, and it is not obvious that the competition between issuers is strong enough to ensure "fair" pricing. We provide the first empirical study on market pricing of MBRCs based on a comprehensive database of 468 certificates outstanding in April 2007. Using a numerical, tree-based valuation method, we obtain an average overpricing of at least 3.4%. This premium on the entire product corresponds to a price discount of 29% on the embedded short put. The overpricing is positively related to the coupon level, indicating that investors tend to overweight the sure coupon and underestimate the risk involved. This behavioral bias appears to be important in explaining the success of the product.

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“…Elaborate pricing techniques have been developed for increasingly complicated structured products. In addition to this enormous technical literature, several interesting empirical studies have recently been published on the actual market prices of structured products in the US (Benet, et al 2006) and in Europe (Wilkens, et al 2003, Grünbichler & Wohlwend 2005, Stoimenov & Wilkens 2005, Szymanowska, et al 2007, Wilkens & Stoimenov 2007, Wallmeier & Diethelm 2008 . However, no comprehensive studies have yet attempted to understand which types of structured products are attractive for private investors and for what motives, although this topic has recently drawn much attention from a number of papers addressing specific puzzles in this field: Henderson & Pearson (2007) studied empirical differences in popular payoff diagrams between structured products with single stocks and stock market indices as underlying assets.…”

Section: Introductionmentioning

confidence: 99%

Can utility optimization explain the demand for structured investment products?

Hens

¹

,

Rieger

²

2013

Quantitative Finance

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In this paper, we first show that for classical rational investors with correct beliefs and constant absolute or constant relative risk aversion, the utility gains from structured products over and above a portfolio consisting of the risk-free asset and the market portfolio are typically much smaller than their fees. This result holds irrespectively of whether the investors can continuously trade the risk-free asset and the market portfolio at no costs or whether they can just buy the assets and hold them to maturity of the structured product. However, when considering behavioural utility functions, such as prospect theory, or investors with incorrect beliefs (arising from probability weighting or probability misestimation), the utility gain can be sizable. Can utility optimization explain the demand for structured investment products?Thorsten Hens * Marc Oliver Rieger † July 2, 2013Abstract In this paper, we first show that for classical rational investors with correct beliefs and constant absolute or constant relative risk aversion, the utility gains from structured products over and above a portfolio consisting of the risk-free asset and the market portfolio are typically much smaller than their fees. This results holds irrespectively of whether the investors can continuously trade the risk-free asset and the market portfolio at no costs or whether they can just buy the assets and hold them to maturity of the structured product. However, when considering behavioral utility functions, such as prospect theory, or investors with incorrect beliefs (arising from probability weighting or probability misestimation), the utility gain can be sizable.JEL classification: G11,D14,C61,D03,D18.

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“…1 Structured products consist of two or more different components, one of which must be a derivative (see Stoimenov and Wilkens (2005)). They are issued by banks and may be addressed to private or institutional investors.…”

Section: Introductionmentioning

confidence: 99%

“…A peared in the most respected Swiss newspaper "Neue Zürcher Zeitung" and the business paper "Finanz und Wirtschaft". 3 See, e.g., Hernandez et al (2007), Benet et al (2006), and Stoimenov and Wilkens (2005).…”

Section: Introductionmentioning

confidence: 99%

Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Wallmeier

¹

,

Diethelm

²

2009

JOD

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The market for structured financial products in Switzerland ranks among the largest in the world. A unique characteristic of the Swiss market is that its most successful products are reverse convertibles on multiple assets with conditional capital protection (multiple barrier reverse convertibles, MBRC). In other countries, an active market only exists for simpler types of reverse convertibles. The valuation of MBRCs is not straightforward, and pricing tools are not yet publicly available. Thus, transparency with respect to fair values might be poor, and it is not obvious that the competition between issuers is strong enough to ensure "fair" pricing. We provide the first empirical study on market pricing of MBRCs based on a comprehensive database of 468 certificates outstanding in April 2007. Using a numerical, tree-based valuation method, we obtain an average overpricing of at least 3.4%. This premium on the entire product corresponds to a price discount of 29% on the embedded short put. The overpricing is positively related to the coupon level, indicating that investors tend to overweight the sure coupon and underestimate the risk involved. This behavioral bias appears to be important in explaining the success of the product.

show abstract

Are structured products ‘fairly’ priced? An analysis of the German market for equity-linked instruments

Cited by 142 publications

References 13 publications

Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Can utility optimization explain the demand for structured investment products?

Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

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