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Essays on Structured Financial Products ESSAYS ON STRUCTURED FINANCIAL PRODUCTS A thesis presented to the Faculty of Management, Economics and Social Sciences at the University of Fribourg (Switzerland) by Vladimir Ani´c from Schmitten FR in fulfillment of the requirements for the degree of Doctor of Economics and Social Sciences Accepted by the Faculty of Management, Economics and Social Sciences on September 21, 2020 at the proposal of Prof. Martin Wallmeier (first supervisor) and Prof. Michael Burkert (second supervisor) Fribourg (Switzerland), 2020 The Faculty of Economics and Social Sciences at the University of Fribourg neither approves nor disapproves the opinions expressed in a doctoral thesis. They are to be considered those of the author. (Decision of the Faculty Council, January 23, 1990) To my wife Jelena and my daughter Maja PREFACE \All great literature is one of two stories; a man goes on a journey or a stranger comes to town." Leo Tolstoy This literature is both of the two stories. I am not sure whether you will find it great. I hope you will though. I would like to express my most sincere gratitude to my first supervisor Prof. Dr. Martin Wallmeier. His wisdom, competence, supportive attitude and sympathy have been invaluable for the completion of this thesis. I could not imagine a better supervisor for any student! I also thank Prof. Dr. Michael Burkert (my second supervisor), Prof. Dr. Berno B¨uchel and Prof. Dr. Holger Herz for very helpful comments and constructive feedback on my work, my colleagues from the Department of Management and the Department of Economics of the University of Fribourg, in particular my office mates Christoph Iseli and Patrick Chardonnens, for the very pleasant cooperation and friendly atmosphere, my parents for their financial support, encouragement and warmth, and my wife Jelena and daughter Maja for everything ♡. I CONTENTS List of Figures VI List of Tables VII List of Abbreviations VIII List of Symbols IX 1 Introduction 1 1.1 What are Structured Products? . .1 1.2 What Is This Thesis About? . .2 2 Constant Leverage Certificates 5 2.1 Introduction . .5 2.2 Characteristics of Constant Leverage Certificates . .8 2.2.1 Specification . .8 2.2.2 Hedging and Pricing . 11 2.2.3 The Effect of Compounding . 13 2.2.4 Comparison with Related Instruments . 15 2.3 Literature Review . 17 2.3.1 Endless Leverage Certificates . 17 2.3.2 Leveraged Exchange-Traded Funds . 18 2.4 Research Design . 21 2.5 Data . 23 2.5.1 Sample Selection . 23 2.5.2 Descriptive Statistics . 24 2.6 Return Deviation and Its Determinants . 26 II CONTENTS 2.6.1 Definition of the Return Deviation Components . 26 2.6.2 Relative Importance of the Return Deviation Components . 27 2.7 Return Generating Process . 30 2.7.1 A Theoretical Model . 30 2.7.2 Simulation-based Model Validation with Constant Volatility . 33 2.7.3 Simulation-based Model Validation with Time-varying Volatility . 37 2.7.4 Model Validation with Empirical Data . 40 2.8 Return Distribution . 42 2.8.1 Theoretical Return Distribution . 43 2.8.2 Historical Return Distribution . 45 2.9 Conclusion . 47 3 Behavioral Aspects of Structured Product Investments 50 3.1 Financial Decision Making and Cognitive Biases in Investment Decisions . 51 3.1.1 Prospect Theory . 51 3.1.2 Salience Theory . 53 3.1.3 Other Cognitive Biases . 54 3.1.4 Cognitive Biases and Structured Product Investments . 56 3.2 Experiments in Finance . 57 3.2.1 Variables and Control . 57 3.2.2 Design . 59 3.2.3 Types of Experiment . 61 3.2.4 (Other) Methodological Challenges . 62 3.3 Perceived Attractiveness of Structured Products . 64 3.3.1 Introduction . 64 3.3.2 Presentation Formats . 66 3.3.3 Designing Tailor-made Structured Products . 70 3.3.4 Experimental Design . 73 3.3.5 Participants . 82 3.3.6 Results . 84 3.3.7 Conclusion . 95 3.4 Myopic Loss Aversion and Structured Product Investments . 97 III CONTENTS 3.4.1 Introduction . 97 3.4.2 Literature Review . 99 3.4.3 Attractiveness of Financial Products over Different Investment Periods under Cumulative Prospect Theory . 102 3.4.4 Experimental Design . 106 3.4.5 Participants . 111 3.4.6 Results . 114 3.4.7 Conclusion . 122 4 Conclusion 124 Bibliography 128 Appendices 137 A Constant Leverage Certificates 138 A.1 Descriptive Statistics of Nominal and Ordinal Variables . 138 A.2 Descriptive Statistics of Issuer Fees . 139 B Perceived Attractiveness of Structured Products 140 B.1 Overview of Variables and Measures . 140 B.2 Experiment . 143 C Myopic Loss Aversion and Structured Product Investments 150 C.1 Return Histograms . 150 C.2 Overview of Variables and Measures . 152 C.3 Experiment . 154 IV LIST OF FIGURES 2.1.1 Price development of randomly chosen CLCs compared to their underlying assets .6 2.2.1 Comparison of different intraday adjustment approaches . 11 2.2.2 Payoff diagram of CLCs in the Eusipa derivative map . 14 2.2.3 Comparison of the performances of a ELC and a CLC in different scenarios . 16 2.5.1 Sample statistics . 25 2.6.1 Mean returns and return deviations . 29 2.7.1 Simulation of the return of four randomly chosen CLCs . 36 2.8.1 Return probability density functions of CLCs based on the theoretical model . 44 2.8.2 Return histograms of CLCs for different holding periods . 46 3.1.1 Prospect theory's value and probability weighting functions . 52 3.2.1 Treatment effects and confounding variables . 58 3.2.2 Experimental designs . 60 3.3.1 Payoff diagram of a collar . 71 3.3.2 Payoff diagrams of the three base products . 74 3.3.3 Risk and return characteristics of the three base products from the first experiment illustrated with histograms and charts with ordered payoffs . 76 3.3.4 Risk and return characteristics of the three base products from the second experi- ment illustrated with histograms and charts with ordered payoffs . 77 3.3.5 Demographical characteristics of the sample by PF groups . 82 3.3.6 Level of (financial) experience . 83 3.3.7 Willingness to take risks . 83 3.3.8 Perceived attractiveness and investment weights for a stock, CPP and RC . 86 3.3.9 Properties of tailor-made structured products . 90 V CONTENTS 3.3.10 Perceived attractiveness and investment weights for the individual (tailor-made) and risk-adjusted product . 92 3.4.1 Cumulative prospect theory utility of various structured and non-structured prod- ucts in different market phases . 105 3.4.2 Histograms of returns for the stock index and RC in setting 1 . 108 3.4.3 Categorical demographical characteristics of the subjects . 112 3.4.4 Numerical characteristics of the subjects . 113 3.4.5 Average investment weights for different products and of different subject groups . 115 3.4.6 Delta investment weights for different products and of different subject groups . 120 VI LIST OF TABLES 2.2.1 Overview of issuers of CLCs and applied adjustment approaches . 10 2.2.2 Comparison of characteristics of CLCs and other leveraged products . 17 2.7.1 Results of the simulation-based model validation with constant volatility . 35 2.7.2 Results of the simulation-based model validation with time-varying volatility and predefined GARCH parameters . 38 2.7.3 Results of the simulation-based model validation with time-varying volatility and fitted GARCH parameters . 39 2.7.4 Results of the model validation with empirical data . 41 3.3.1 Regression analysis of perceived attractiveness and investment weights for the stock, the CPP and the RC . 88 3.3.2 Regression analysis of the properties of tailor-made products . 91 3.3.3 Deviation between the attractiveness (or, alternatively, the investment weights) of individual (tailor-made) products and risk-adjusted reference instruments for different subject groups . 93 3.3.4 Regression analysis of perceived attractiveness and investment weights for the in- dividual (tailor-made) product and the risk-adjusted reference instrument . 94 3.4.1 Overview of experimental settings . 107 3.4.2 Overview of treatment variables . 109 3.4.3 Regression analysis of investment weights of the stock index in different settings . 118 3.4.4 Regression analysis of investment weights of the RC in different settings . 119 VII LIST OF ABBREVIATIONS CLC Constant leverage certificate CPP Capital protection product DAX German stock index DJIA Dow Jones Industrial Average ELC Endless leverage certificate ETF Exchange-traded fund Eusipa European Structured Investment Products Association GARCH Generalized autoregressive conditional.
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