Recent Academic Research

Leveraged ETF performance, effects from Brazil's monetary policy, value in sell-side analyst reports, and economic impact from housing market cycles

Mar 08, 2025

Welcome back to another issue of Recent Academic Research! I’ve got some interesting papers from this past week. Let me know in the poll which one you enjoyed the most!

Let’s get into it.

Leveraged ETF Long Term Performance

Leveraged ETFs (LETFs) aim to deliver a multiple of an index’s daily return, but critics argue that their frequent rebalancing leads to long-term underperformance compared to a static leverage approach. This paper challenges that assumption through theoretical analysis and simulations. Using data from five indices over various holding periods, the study finds that LETFs generally track their intended leverage well beyond a single day, contrary to claims of value erosion.

Findings:

LETFs do not consistently underperform their non-reset portfolios, debunking the long-term value decay argument.
Deviations from expected returns are largely influenced by volatility and holding period but tend to be positively skewed, meaning LETFs more often outperform than underperform.
LETFs maintain high correlation with their non-reset counterparts, especially over shorter holding periods (under 63 days). Even for longer periods (252 days), correlation remains strong in most cases, particularly for lower-volatility indices.

This paper supports the findings that I showcased in my post on volatility decay and optimal market leverage. The authors argue that LETF critics fail to account for financing costs of non-reset portfolios. Additionally, LETFs exhibit a momentum pattern as the managers have to increase their exposure after positive return days (and decrease exposure after negative return days) in order to match the target leverage. Lastly, compounding effects can benefit LETFs in trending markets, as gains are amplified when prices continue in the same direction, while losses are mitigated since exposure is reduced after negative return days.

Wang, Baolian, Multi-day Return Properties of Leveraged Index ETFs (January 31, 2025). Available at SSRN: https://ssrn.com/abstract=5119860 or http://dx.doi.org/10.2139/ssrn.5119860

Brazil’s Monetary Policy Effects

The paper examines the impact of high-frequency monetary policy shocks in Brazil, using daily data and an identification strategy based on heteroskedasticity. Traditional methods struggle to isolate exogenous policy shocks, so the authors employ an instrumental variable (IV) approach to improve accuracy. The study focuses on how unexpected changes in interest rates set by Brazil’s central bank (Copom) affect inflation expectations, exchange rates, and sovereign risk premiums.

Findings:

When Copom raises interest rates more than expected, inflation expectations decline across all maturities, with stronger effects at longer horizons.
Naïve OLS estimates incorrectly suggest higher rates increase inflation expectations due to endogeneity, but IV results confirm a textbook-like response—higher rates lead to lower expected inflation.
Unexpected rate hikes also cause the Brazilian real to appreciate against the U.S. dollar, contradicting the theory that higher rates increase default risk and depreciate the currency.

Most of these findings align with economic intuition. When Brazil’s central bank raises interest rates, the higher returns attract investors, increasing demand for the local currency and leading to an appreciation. However, well-known market relationships do not always hold in practice, especially in emerging economies. This study provides valuable empirical evidence confirming these effects in Brazil, reinforcing the role of monetary policy in shaping expectations.

Goncalves, Carlos and Rodrigues, Mauro and Genta, Fernando, Monetary Policy and Inflation Expectations. IMF Working Paper No. 2025/048, Available at SSRN: https://ssrn.com/abstract=5166242 or http://dx.doi.org/10.5089/9798229003537.001

Predictive Value in Sell-Side Analyst Reports

The study investigates whether narratives in sell-side analyst reports predict future stock returns. While prior research has focused on numerical forecasts, this paper examines textual content using large language models. By analyzing 1.2 million reports from 2000 to 2023, the author finds that text-based insights provide additional predictive power beyond traditional analyst recommendations and fundamental-based factors.

Findings:

Reports with negative sentiment but positive long-term outlooks predict significant future stock outperformance, suggesting market overreaction to short-term negative news.
A long-short trading strategy based on report-derived return forecasts generates an average monthly return of 1.04%, with an alpha of 68 basis points relative to the Fama-French five-factor model.
The predictive power is strongest for large, mature firms and reports written by experienced analysts, implying that skilled analysts identify mispriced long-term opportunities.
Strategic Outlook discussions within reports contribute the most to predictive power, while conventional financial analysis adds limited value, suggesting that forward-looking qualitative insights are underappreciated by the market.

Sell-side analysts reading this week’s edition will likely be pleased with this study. Given their deep industry knowledge, it’s not surprising that their insights contain valuable information.

Lv, Linying. "Do Sell-side Analyst Reports Have Investment Value?." arXiv preprint arXiv:2502.20489 (2025). https://doi.org/10.48550/arXiv.2502.20489

Housing Cycles’ Impact on the Economy

The paper examines how different types of housing expansions impact the broader economy, distinguishing between moderate price increases and housing booms. Analyzing 180 housing cycles across 68 countries from 1970 to 2023, the authors identify nearly half as housing booms, defined by rapid and persistent price growth. They use local projection methods to study economic patterns during expansions and contractions.

Findings:

Housing booms lead to stronger GDP and private consumption growth compared to non-boom expansions, largely due to wealth effects and increased borrowing.
However, economic downturns following housing booms are significantly deeper and longer-lasting than those following moderate expansions.
The severity of the downturn increases with the intensity of the prior boom, especially when fueled by excessive household credit growth.
Countries with more flexible housing supply and stricter macroprudential policies (e.g., loan-to-value and debt-to-income limits) experience milder contractions after housing booms.

The housing market plays a major role in the broader economy and is closely tied to economic cycles. The paper’s findings were evident during the 2008 Global Financial Crisis, when loose mortgage regulations fueled a housing boom that ultimately led to a severe downturn.

Albuquerque, Bruno and Cerutti, Eugenio and Kido, Yosuke and Varghese, Richard, Not All Housing Cycles are Created Equal. IMF Working Paper No. 2025/050, Available at SSRN: https://ssrn.com/abstract=5166244 or http://dx.doi.org/10.5089/9798229002615.001

Feedback

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