Analysis of the Impact of Leveraged ETF Rebalancing Trades on the Underlying Asset Market Using Artificial Market Simulation

Abstract

Financial markets occasionally become highly volatile, as a result of a financial crisis or other factors. Previously, index futures trading and program trading have been singled out as direct causes of market destabilization, but more recently it has been suggested that leveraged ETFs (funds aimed at amplifying several-fold the movement of a price index such as the Nikkei Stock Average or underlying assets) rebalancing trades may also be a factor. This study uses a financial market simulation (artificial market) constructed virtually on a computer to assess the impact of leveraged ETF rebalancing trades on the underlying assets market. Analysis results showed that a larger amount of the managed assets of leveraged ETFs corresponds to a higher volatility of the underlying securities market. They also demonstrated that leveraged ETF trading can destroy the underlying assets market, if the leveraged ETF trading impact on the market is greater than that of ordinary volatility of the underlying assets.