The Optimal Demand for Retail Derivatives

It has been shown that investors can benefit from including derivatives into theirportfolios. For retail investors, however, a direct investment in derivatives is oftentoo complicated. Investment certificates offer a potential solution to this problem.We analyze if retail investors who buy and hold their portfolio for one year can indeedbenefit from an investment in these certificates.We use a model with stochasticvolatility and jumps calibrated to the German stock market index DAX. We findthat the benefit of investing in typical retail products is equivalent to an annualizedrisk-free excess return of at most 35 basis points for a CRRA investor with a lowrisk aversion. If we take transaction costs into account, this number reduces to atmost 14 bp. In terms of the types of contracts, we find that discount certificates performbest, while more sophisticated certificates, in particular those with knock-in orknock-out features, should often not be held by investors at all. Therefore, standardpreferences cannot explain the large observed demand for investment certificates.