Abstract

Trading and Pricing of Index Certificates

Nicole Branger
T. Kirchner

Universität Karlsruhe

Index Certificates are paying a given fraction of an index at maturity. They are designed to enable an investor to participate at the performance of the index without having to buy every asset contained in the index. In the first part of the paper, we describe the German market for index certificates on the DAX as an example for the trading in index certificates. Trading takes place both at the exchange and OTC. Notwithstanding differences in the contracts concerning maturity and possible caps, trading is concentraded in a few certificates. Comparing the bid-ask-spreads from index certificates, a DAX basket and a DAX-Future shows that there exist significant different trading costs for instruments which have (nearly) the same payoff. The second part of the paper comprises an empirical analysis of the pricing of index certificates. The price processes of the DAX future, the Xetra-DAX, and of two chosen index certificates are investigated using the concept of cointegration which allows to analyse the lead-lag-characteristics of the prices and the contribution of each market to price discovery. Estimating an error correction model, we see that the prices of each index certificate stick closer to the futures price than to the Xetra-DAX. Furthermore, representing the results as a common trend model, we see that the market for index certificates does not contribute to the price discovery for the DAX. These empirical results are mainly caused by the special structure of market participants (issuers, private investors) and hedging activities.