Are Concerns About Leveraged ETFs Overblown?

Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are likely exaggerated because they ignore the effects of capital ows on ETF rebalancing demand. Empirically, we find that capital ows substantially reduce the need for ETFs to rebalance when returns are large in magnitude and, therefore, mitigate the potential for these products to amplify volatility. We also show theoretically that ows can completely eliminate ETF rebalancing in the limit. [ABSTRACT FROM AUTHOR]