Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

The market for structured financial products in Switzerland ranks among the largest in the world. A unique characteristic of the Swiss market is that its most successful products are reverse convertibles on multiple assets with conditional capital protection (multiple barrier reverse convertibles, MBRC). In other countries, an active market only exists for simpler types of reverse convertibles. The valuation of MBRCs is not straightforward, and pricing tools are not yet publicly available. Thus, transparency with respect to fair values might be poor, and it is not obvious that the competition between issuers is strong enough to ensure “fair” pricing. We provide the first empirical study on market pricing of MBRCs based on a comprehensive database of 468 certificates outstanding in April 2007. Using a numerical, tree-based valuation method, we obtain an average overpricing of at least 3.4%. This premium on the entire product corresponds to a price discount of 29% on the embedded short put. The overpricing is positively related to the coupon level, indicating that investors tend to overweight the sure coupon and underestimate the risk involved. This behavioral bias appears to be important in explaining the success of the product. JEL classification: G13; G15; G14