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The Journal of Derivatives

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Locally Capped Investment Products and the Retail
Investor

Carole Bernard, Phelim P. Boyle and William Gornall
The Journal of Derivatives Summer 2011, 18 (4) 72-88; DOI: https://doi.org/10.3905/jod.2011.18.4.072
Carole Bernard
is an assistant professor at the University of Waterloo, Waterloo, ON, Canada.
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  • For correspondence: c3bernar@uwaterloo.ca
Phelim P. Boyle
is a full professor in the School of Business and Economics, Wilfrid Laurier University in Waterloo, ON, Canada.
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  • For correspondence: pboyle@wlu.ca
William Gornall
is a Ph.D. student at the Stanford Graduate School of Business in Stanford, CA.
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  • For correspondence: wrgornall@gmail.com
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Abstract

This article explores a different type of structured retail product with a payoff that is heavily path dependent. Formally, these securities are “locally capped and globally floored.”That is, the payoff consists of an overall minimum guaranteed return over the contract’s lifetime, plus a variable return cumulated over a series of subperiods, which is calculated as the lower of the actual percentage change in an underlying index in that period or a fixed ceiling rate. Again, this highly path-dependent payoff is difficult to value. The contracts are typically substantially overpriced relative to their fair values, by about 6.5% on average. But beyond showing that average investor returns are below what they should be, the authors offer some insight into why unsophisticated investors buy products that they don’t fully understand. They show how the issuers offer cherry-picked examples in their promotional literature in which the investor’s return from the contract is better than that from alternative strategies, without explaining how improbable the scenarios are relative to the much more likely cases in which the instrument underperforms.

TOPICS: Futures and forward contracts, theory

  • © 2011 Pageant Media Ltd
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The Journal of Derivatives: 18 (4)
The Journal of Derivatives
Vol. 18, Issue 4
Summer 2011
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Locally Capped Investment Products and the Retail
Investor
Carole Bernard, Phelim P. Boyle, William Gornall
The Journal of Derivatives May 2011, 18 (4) 72-88; DOI: 10.3905/jod.2011.18.4.072

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Locally Capped Investment Products and the Retail
Investor
Carole Bernard, Phelim P. Boyle, William Gornall
The Journal of Derivatives May 2011, 18 (4) 72-88; DOI: 10.3905/jod.2011.18.4.072
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  • Article
    • Abstract
    • DESCRIPTION AND TERMINOLOGY
    • THE MARKET FOR LOCALLY CAPPED PRODUCTS
    • VALUATION
    • EMPIRICAL RESULTS
    • AN EXAMPLE ILLUSTRATING CREDIT RISK
    • SUMMARY AND CONCLUSION
    • APPENDIX A
    • ENDNOTES
    • REFERENCES
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