Daily Leveraged ETF Rebalancing under Market Frictions

Leveraged Exchange-Traded Fund is an instrument that aims at target daily returns equal to a constant multiple of underlying daily returns. Common LETF rebalancing strategies involve large transactions daily right before... [ view full abstract ]

Leveraged Exchange-Traded Fund is an instrument that aims at target daily returns equal to a constant multiple of underlying daily returns. Common LETF rebalancing strategies involve large transactions daily right before market closure, which is costly due to market frictions like transaction costs and front-running. We propose a stochastic control model involving market frictions and market closure, and find the optimal intraday rebalancing strategy explicitly. The optimal strategy strikes a balance between today's optimal leverage and preparation for tomorrow, exhibiting a U-shaped trading pattern. Also, we observe slippage in our model, consistent with the empirical findings on LETF return deviations.