The Pricing of Path-Dependent Structured Financial Retail Products:<i>The Case of Bonus Certificates</i>

Baule, Rainer; Tallau, Christian

doi:10.3905/jod.2011.2011.1.012

Cited by 28 publications

(22 citation statements)

References 24 publications

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“…This is in line with studies on trading behavior in mutual funds (e.g. Grinblatt and Titmann (1989), Grinblatt and Titmann (1993), Brown and Goetzmann (1995), Carhart (1997), Daniel et al (1997), Chan et al (2000), Wermers (2000), Coval and Moskowitz (2001) and Kosowski et al (2006), see Murstein (2003) for the resulting trade pattern) and in financial products with asymmetric payoffs (Baule and Tallau (2011)) indicate that other trading motives may exist that mimic trade pattern from Prospect Theory (regarding trading in mutual funds see Weisbrenner (2009), Chang et al (2012), for trading in structured products see Entrop et al (2013)), thus probably leading to systematic biases in the calibration of the parameter set. about p t , R D,t and R U,t of the stocks underlying the trades in our dataset.…”

supporting

confidence: 58%

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

2016

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Abstract. Shortcomings revealed by experimental and theoretical researchers such as Allais (1953), Rabin (2000) and Rabin and Thaler (2001) that put the classical expected utility paradigm von Neumann and Morgenstern (1947) into question, led to the proposition of alternative and generalized utility functions, that intend to improve descriptive accuracy. The perhaps best known among those alternative preference theories, that has attracted much popularity among economists, is the so called Prospect Theory by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). Its distinctive features, governed by its set of risk parameters such as risk sensitivity, loss aversion and decision weights, stimulated a series of economic and financial models that build on the previously estimated parameter values by Tversky and Kahneman (1992) to analyze and explain various empirical phenomena for which expected utility doesn't seem to offer a satisfying rationale. In this paper, after providing a brief overview of the relevant literature, we take a closer look at one of those papers, the trading model of Vlcek and Hens (2011) and analyze its implications on Prospect Theory parameters using an adopted maximum likelihood approach for a dataset of 656 individual investors from a large German discount brokerage firm. We find evidence that investors in our dataset are moderately averse to large losses and display high risk sensitivity, supporting the main assumptions of Prospect Theory.

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supporting

confidence: 58%

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

2016

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“…In fact, theoretical models imply that investors' demand for certificates can hardly be justified by standard preferences (Breuer and Perst, 2007;Branger and Breuer, 2008;Bernard 1 Other studies reporting overpricing include for the US Chen and Kensinger (1990); Chen and Sears (1990); Baubonis et al (1993); Benet et al (2006), for Germany Stoimenov and Wilkens (2005); Muck (2006); Wilkens and Stoimenov (2007); Baule et al (2008); Baule (2011); Baule and Tallau (2011), for Switzerland Wasserfallen and Schenk (1996); Burth et al (2001); Grünbichler and Wohlwend (2005); Wallmeier and Diethelm (2009), and for the Netherlands Szymanowska et al (2009).…”

Section: Introductionmentioning

confidence: 99%

Market makers’ optimal price-setting policy for exchange-traded certificates

Baller

Entrop

McKenzie

et al. 2016

Journal of Banking & Finance

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This paper considers the pricing of certificates on exchanges for retail investors. The contribution to the literature is twofold: (i) We provide the first theoretical model that analyzes the optimal, i.e. profit-maximizing price-setting policy of the issuer over a certificate's life time. Our model derives and examines the nexus between optimal markup and optimal spread inter-temporally set by the issuer, unhedgeable risk faced by the issuer, and investors' buying and selling decisions. (ii) Analyzing the German market for leverage certificates, we provide the first comprehensive empirical analysis of model-derived hypotheses on the issuers' pricing policies that accounts for possible endogeneity between markup and spread and concretizes the effects of unhedgeable risk, volume and order flow.

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“…Hernández et al (2007) present valuation formulas for several types of reverse convertibles with embedded barrier options within the BS model and find significant underpricing of these instruments. Baule and Tallau (2011) studied the valuation of a related type of structured product -bonus certificates -in the context of the Heston model. Bonus certificates are similar in structure to reverse convertibles.…”

Section: Billion) In 2010 Accordingmentioning

confidence: 99%

“…The main difference is that bonus certificates embeds a down-and-out put option rather than the down-and-in put option embedded in reverse convertibles. Baule and Tallau (2011) used simulations to price the bonus certificates under the Heston model. Lipton (2001) presents a closed-form valuation of barrier options using a Green's function approach within a special case of the Heston model where the asset price and volatility are assumed to be uncorrelated.…”

Section: Billion) In 2010 Accordingmentioning

confidence: 99%

Valuation of reverse convertibles in the variance gamma economy

Deng¹,

Dulaney²,

McCann³

2013

J Deriv Hedge Funds

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Prior research on structured products has demonstrated that equity-linked notes (ELNs) sold to retail investors in initial public offerings are typically issued at above their fair market value. A particular type of ELN -reverse convertibles -embed down-andin put options and offer investors relatively high coupon payments in exchange for bearing some of the downside risk of the equity underlying the note. We analytically study the magnitude of the overpricing of reverse convertibles -one of the most popular structured products on the market today -within a stochastic volatility model.We extend the current literature to include analytical valuation formulas within a model of stochastic volatilitythe variance gamma (VG) model. We show that these complex notes are even more overpriced than previously estimated when stochastic volatility is taken into account. As a result of their complex payoffs and the lack of a secondary market to correct the mispricing,

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The Pricing of Path-Dependent Structured Financial Retail Products:The Case of Bonus Certificates

Cited by 28 publications

References 24 publications

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

Taming Models of Prospect Theory in the Wild? Estimation of Vlcek and Hens (2011)

Market makers’ optimal price-setting policy for exchange-traded certificates

Valuation of reverse convertibles in the variance gamma economy

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