Internship Report

Benjamin Noyan
412276

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 Credit Suisse At A Glance
The work report
Having spent the past 6 months at Credit Suisses headquarter in Zurich, Switzerland, I
not only learned about skills and tasks in Sales & Trading, but also about Credit Suisse
itself. As one of the worlds biggest and most successful financial institutions, it is not the
easiest to put the entire company into a nutshell. However, I am confident that the
following sections will provide a good overview about Credit Suisses history, strategy,
products, and culture as well as the Market it operates in. In spite of the restructuring and
re-orientation of the banks strategy, I will put special emphasis on how the restructuring
and the resulting new strategic path that secures Credit Suisse a competitive advantage as
well as how it influences the internal structures. However, in order to understand Credit
Suisses current market position, it is important to understand its roots and evolvement.
Therefore, this report starts with an outline of Credit Suisses history.

Credit Suisses History

In 1856, Alfred Escher, a prominent Swiss politician, business leader, and pioneer
founded the Schweizerische Kreditanstalt, nowadays Credit Suisse. The reason behind
this foundation was to finance the expansion of the railroad network in Switzerland and
boost industrialisation. Within 3 days of the issuance of initial stock, the banks value
increased by about 72 times. During the next century and a half this success continued
and Credit Suisse turned into a pioneer for innovation in the financial markets. While it
was the first European bank that established a direct telex connection with New Work in
1951, it also was one of the first launching a telephone and internet banking platform in
the 1990s (Credit Suisse 1). In addition, Credit Suisse operated the worlds largest dark
pool, namely Crossfinder. Dark pools are privately held electronic trading platforms that
allow both buyers and sellers to make anonymous bids and orders until executed (John
McCrank 2013). Another important aspect of Credit Suisses history is its long tradition
of focusing its mission and operations around the their clients needs. This not only
fuelled the banks innovativeness, but is also a crucial aspect of its culture and leadership
style. The report will talk in more depth about this issue in later sections

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Credit Suisses Strategy
Facts & Figures
Credit Suisse belongs to the bulge bracket investment banks, meaning it is one of the 10
largest and most profitable multi-national investment banks worldwide (WallStreetOasis).
Currently, there are about 48000 employees working in one of the 550 offices that are
spread over 52 countries (Credit Suisse 2). Since its foundation in 1856, Credit Suisse is
headquartered in Zurich, at the famous Paradeplatz. The Assets under Management at
end of 2015 amounted to 1214 billion CHF (Credit Suisse 3).

Restructuring
Before going more into detail about Credit Suisses current strategic orientation, it is
important to understand its changes in the past that ultimately led to the restructuring
taking place since 1.5 years. When the new CEO, Tidjane Thiam, displaced the
investment banker Tim OHara, Credit Suisse started to redirect its strategic focus,
structure, as well as organisation of the group. As the name already implies, investment
banks focus their strategy around investment banking services. These include sales &
trading, M&A, equity & debt capital market, and corporate lending services as well as the
related middle-& back office tasks. Since, the financial crisis in 2007/2008 and the
following increase in regulations and restrictions as well as the decreasing investor
confidence, profitability in the investment banking industry declined and competition
from more flexible FinTech firms increased. Some investment banks, like Morgan Stanley
or JP Morgan realised this already in 2009/2010 and started to change their strategic

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orientation, providing them a front-runner advantage nowadays.
Credit Suisse realised this urge to change their strategic structure only when Thiam, a
former Mc Kinsey Partner & CEO of Prudential, took office at the beginning of 2015.
Whereas some competitors restructured towards a stronger private banking arm (BoA,
Citi, HSBC) or a technology pioneer strategy (GoldmanSachs, JP Morgan, Morgan
Stanley), Thiam and the board decided to strengthen Credit Suisses position as a leading
wealth manager and private bank. Thereby, it aimed to gain a competitive edge by
diversifying itself from its main competitors. In addition, to this overall strategy, it lays a
considerable focus to lead the wealth management industry in emerging markets, the
largest of which is in the Asia Pacific region as well as its home country, Switzerland
(Credit Suisse 4). Another big aspect of the mission to make Credit Suisse more
competitive again is to implement initiatives that drive cost savings and decrease volatile
earnings.

The New Strategy

Declining returns and uncertain future prospects since the financial crisis are the decisive
factors for Credit Suisses diversification and specialisation strategy. During the last 2
years, management decided to decline the business exposure in less profitable fields and
areas, while expanding businesses with more profitable prospects. To provide an
understanding about Credit Suisses current strategic outline, it is important to
understand the new business structure that evolved from the restructuring. The integrated
business model of Credit Suisse is structured into 5 decisive units, which are controlled by
the management board. Please note that a more detailed description about the
organisational culture, structure, and leadership will follow in the self-reflection report.

1) Swiss Universal Bank

The Swiss Universal Bank is a business unit, developed in 2012 in order to foster Credit
Suisses business opportunities in Switzerland. It provides financial solutions in terms of
both Private Banking as well as Corporate & Institutional Banking to over 1.6 million
clients and 100.000 corporations (Credit Suisse 5). Net income pre tax in 2015 amounted
to 1.61 billion. The 2018 target of 2.35 billion (net growth of 46%) shows Credit Suisses
aim to strengthen its competitive position in Switzerland, a key pillar of the banks success
(Credit Suisse 6). Despite continued regulatory and macro risks, the Swiss market
regained momentum in 2016. Switzerland is renowned for the highest density of
millionaires and assets of Ultra High Net-Worth Individuals (UHNWI) and High Net-
Worth Individuals (HNWI) are forecasted to grow by 8% till 2018, which could provide
new opportunities for Credit Suisses Swiss Universal Bank (SECO 2016). Besides the

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expected positive real GDP growth forecasts in Switzerland, Credit Suisse announced an
IPO of its Swiss legal entity in order to advance its business and foster investor
relationships, which is planned for Q1 2017 (Credit Suisse 5). The proceeds of the IPO
will not only be used to strengthen its position in Switzerland, but also to reinvest them
into Credit Suisses wealth management division, especially in the Asia-Pacific area.

1) International Wealth Management (IWM)

Within the IWM division, Credit Suisse diversifies between Private Banking and Asset
Management. Under Private Banking, one understands the offering of tailored financial
solutions and investment advice to wealthy private clients and external asset managers
(EAMs). Opposed to Asset Management, Private Banking can draw on both internal as
well as external products. The Asset Management business provides investment solutions
and recommendations (as well as research) to professional investors such as pension funds,
hedge funds, fund of funds, mutual funds, governments, EAMs, and more. As of end-Q2
2016, the assets under management in IWM (both Private Banking and Asset
Management) summed up to more than 650 billion CHF, which is about 50% of Credit
Suisses total assets under management. IWM is the key aspect of the restructuring that is
taking place since 1.5 years. While Thiam and the management board decided to cut
back on some of the more unprofitable businesses, like Global Markets and Investment
Banking, Credit Suisse aims to expand its IWM operations. Attractive growth prospects
in Russia & Eastern Europe (10%), Middle East (10%) and Latin America (7%) are
probably the vital drivers for the strategic change. In spite of the challenges in other
business areas, Credit Suisses new strategy aims to leverage its investment banking
expertise to support and strengthen IWM clients and businesses. The main goals of the
IWM division are to deliver consistent client value as well as to capture revenue potential
through integrated client coverage (Credit Suisse 7). One step to reach these targets is by
increasing the sales force in emerging markets (300 additional relationship managers by
2018) and adapting new technological advancements that allow wealth managers to
increase productivity and efficiency.

1) Asia Pacific
While IWM is the central business area of the new strategic orientation, the Asian Pacific
market is clearly the new geographical focus. Within IWM, Thiam and the management
board decided to focus on expanding the business especially in Asia Pacific in order to
capture the significant prospects in these markets. It is expected that the Asian Pacific
area will account for 55% to 60% of global wealth growth as of end-2018, driven by new
businesses and FDIs (Credit Suisse 5) (Bullock & McCrum 2015). Within the area, Credit
Suisse focuses its IWM and Investment Banking activities especially on the fastest growing
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markets in China, Japan, India, Indonesia, Singapore, Hong Kong, South Korea,
Australia as well as New Zealand. The overall goal is to double Asia-Pacific income and
client assets by 2018 with the means of fostering wealth management services and making
significant investments of capital and resources in order to grow a leading brand in the
Asian market. A central part of the Asia-Pacific strategy is to be recognised as the
Trusted Entrepreneurs Bank of Asia Pacific. Additionally, Credit Suisse wants to focus
on UHNWI client activity due to the prosperous long-term outlook in Asian wealth
creation and the resulting business opportunities.

1) Global Markets
The global markets division, which is responsible for all sales, trading, and structuring
(STS) activities, is the unit that has been most pressurised under the new strategic
orientation. While Tim OHara announced shortly before his displacement that he wants
to shift the focus of Credit Suisses Sales & Trading activities to the US, Thiam and his
strategy team chose a different path. Under the new plan, the STS division focuses on 3
primary strategic goals: (1) prioritising businesses and operations that are connected to
private banking clients; (2) optimising the capital structure by focusing on cost efficiencies;
(3) increasing profitability by focusing on businesses that deliver profitability in excess of
their expenses and cutting down on others (Credit Suisse 5). Opposed to the previous
STS strategy, the new structure aims to reduce earnings volatility by cutting down
unprofitable businesses and trying to connect efficient ones with IWM and PB services.
Thiam and the management team formed this strategy to align it to the new strategic
path of the Credit Suisse Group.
Businesses that management sees as important for PB clients are cash equities, equity
derivatives, structured notes, and emerging markets. The idea is to optimise prime
services that demonstrated important investment channels for private and retail banking
clients. On the IWM side, Credit Suisse focuses on share-backed lending and structured
financing products as well as securitised products and credit trading, which are key
drivers for CS profit. The businesses that get downsized are macro, syndicate, bond, and
commodity businesses. In the US, the entire trading business, except foreign exchange
and swap trading, has been partially shut down or moved to Zurich in order to achieve
the desired cost improvements. The further activities to cut down the cost of capital in
STS will be further analysed in section 1.4.

1) Investment Banking & Capital Markets

The Investment Banking & Capital Market (IBCM) division offers services such as M&A
advisory, divestitures, takeover defence, restructuring, spin-offs as well public offerings of

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debt and equity underwriting. Regional and local teams in major business areas are
delivering customised IBCM solutions to institutional clients all over the world. The focus
is currently shifting from the US to emerging markets, especially in Asian Pacific. While
IBCM and GM were the key businesses for CS in the past, IWM substituted them.
Especially macro-economical and institutional challenges as well as the tightened
profitability in these industries were a good reason for this strategic re-focus. The IBCM
strategy focuses on (1) intensifying the client coverage cycle for UHNWI clients in the US
as well as to (2) rebalance the M&A advisory services towards a price-leadership strategy
in certain key IBCM markets (such as US, UK, middle Europe, Asia Pacific). In addition,
a key driver for the new strategy are emerging markets, in which IBCM activities are
expected to grow according to internal analysis. However, due to rather weak
performances in 2015, the IBCM business unit underwent a strict cost-cut program.

Having outlined the new strategic direction of each division allows concluding this section
by putting them together to analyse CS group strategy. While the trend in the financial
industry tends to go forward by focusing on new income streams and technological
innovations, CS decided to strengthen their competitive position by going back to their
roots, Wealth Management and Private Banking. The overall long-term objective is to
create a structure, which is more flexible in responding to clients needs by leveraging the
combined expertise and resources in private wealth management and investment
banking. As the GM and IB businesses do merely demonstrate supportive functions,
management decided to reduce its size in order to optimise earnings and its volatility. In
addition, a central part of the new strategy is its focus on wealth management services in
emerging markets, especially China, Japan, Korea, India, and Indonesia. Although CS
rose about CHF 3.5 billion through selling assets and cutting down businesses, CS
strategic change had a very negative effect on its stock price as well as investors and
shareholders confidence (Noonan 2016). One of the reasons that might be behind this
negative effect on investors confidence might be that the new strategic plan makes Credit
Suisses new structure more like UBS, Switzerland's biggest bank, only that UBS already
finished its transition from IB to IWM in 2014. Additionally, what is very interesting is
that the detailed description of CS strategy does not mention the word innovation or
technology even once, although these strategic aspects are inevitable in the fast paced
financial service industry.

Challenges and Opportunities in the Current Market

Despite the uncertainty in financial markets, CS faces about 8 key risks across their
divisions. Certainly one may find additional risks, however, the ones outlined are the most

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severe and dramatic ones. The following list is not ordered, since failing to recognise and
prevent any of the outlined risks may have disastrous consequences on CS reputation
and financials.
1. Liquidity Risks: In todays stressed liquidity environment, it is crucial for any bank to
have enough funds available to successfully operate and invest in certain businesses.
CS counteracts this risk by raising funds through selling assets and issuing equity for
the SUB.
2. Market Risks: All businesses across CS new strategy are subject to the risk of loss
from adverse market conditions and unfavourable economic, political, or monetary
developments. CS aims to minimise the resulting losses by reducing large investment
positions as well as downsizing the most volatile businesses, IB and GM.
3. Regulatory Risks: Across all business units, CS as well as every other financial
institution faces increasing risks related to financial market regulations. As a globally
operating bank, CS is subject to various legal proceedings, regulatory actions, and
investigations. An adverse result in any of these could have tremendous effects on its
operations. In addition, regulatory changes may negatively affect operations and CS
ability to execute its strategy. As a consequence, CS created a resolution group as well
as clear compliance guidelines.
4. Litigation Risks: These risks are related to regulatory risks, however focus on fines and
prosecutions of past actions that violated one or more regulations. Considering the
financial crisis in 2008 and the following tightening of legislations, many banks faced a
largely increasing amount of investigations into past operations, resulting in severe
fines (Irving 2014).
5. Credit Risks: The credit exposure across a wide range of transactions is subject to
risks of loss if counterparties are defaulting or unable to perform their obligations. To
decrease this counterparty risk, CS performs regular creditworthiness reviews of
clients and counterparties.
6. Strategic Risks: The new strategic direction and structure is based upon several
assumptions of future economic developments. In case these assumption turn out to
be wrong, the effects on CS competitiveness and effectiveness could be at risk.
7. Currency Risks: Fluctuation in exchange rates could adversely affect operational
results and incur considerable losses of investments in foreign countries and
currencies.
8. Operational Risks: Inadequate or Failing internal processes or systems are subject to
operation risks and consequently operational losses. As the majority of CS operations
depend on information technology, any failure in collecting or storing information
and data may lead to losses as well as regulatory issues.

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 Coupon Hunting in Switzerland:
An analysis of the Swiss Reverse Convertible and
Barrier Reverse Convertible Market

Internship Report - Working Paper

Noyan Benjamin
February 2017

Abstract:
In my research, I observe investors yield preferences for Reverse Convertibles and
Barrier Reverse Convertibles in Europes two largest markets for structured
products, Switzerland and Germany. By analysing and comparing more than
13,000 products in two empirical frameworks, this paper finds that the average
Swiss investor tends to demand higher yield rates than the average German investor
does. I also prove that the underlying drivers of these yield rates differ between the
two countries, which is surprising when one considers the proximity of the markets.
Based on the empirical findings that Swiss investors tend to buy Reverse
Convertibles and Barrier Reverse Convertibles with higher risk as well as yield
levels, I draw on the insights of behavioural finance in order to explain the
fundamental principles of this investment pattern. Specifically, I link RC and BRC
market specific situations to some of the most renowned herding theories and find
four key factors that prove herding to be a central driver of above average coupon
rates in Switzerland.

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1 Introduction
Structured products (SPs) are financial vehicles that bundle a traditional security with a
derivative to a single investment instrument. The theoretical spectrum of SPs is unlimited
due to the large variety of incorporable assets (equity, fixed income, rates, commodities,
currencies, inflation1, volatility2) as well as the broad range of derivative instruments
(Futures, Forwards, Swaps, Options). In practice, only a limited number of products are
applicable and attractive for investors, considering the products cost-return profile. A key
characteristic of a SP is its payoff function, which is a pre-specified equation defining the
return at maturity (and at any early redemption date) considering every potential
scenario. A key advantage of SPs is its flexibility, which allows investors to customize a
products return profile according to certain portfolio strategies. Opposed to direct
investments, SPs pose an alternative that might help mitigating a portfolios risk exposure
(Ofir and Wiener 2009). Additionally, investors can customize a specific payment
schedule, being either periodical or only at maturity. These can be achieved either with
coupons (fixed or floating rates 3 ) or bonus payments (the payout depends on the
underlyings performance). Besides hedging portfolio positions, mitigating risks, or
optimizing yields, SPs are often implemented to collect returns from rising interest rates,
enter new markets (emerging markets, illiquid assets, etc.) as well as to diversify a portfolio
with alternative assets. Its original roots date back to 1,750 B.C. when derivatives enabled
farmers to hedge fluctuations in harvest prices in order to ensure a sufficient and steady
income. In the 1980s, the underlying product strategy underwent a significant change
from pure risk mitigation products into speculation vehicles.
Investors in SPs range from big institutional investors to corporations, different types of
funds, high-net-worth individuals, and retail investors. Various financial institutions issue
SPs with the aim to provide their customers a broad range of customizable investment
instruments. In contrast to offering traditional investments, the issuer charges a co-
structuring-fee, which is usually between 0.50% and 4.00% of the investment amount, as
well as an additional sales fee. These fees vary by structure and increase with the
complexity of a product. It can be considered as an issuers compensation for constructing
and issuing a SP. Nevertheless, in contrast to most funds (mutual funds, hedge funds, fund
of funds, etc.) SPs do not entail a running management fee or a performance fee, which
outlines its benefit opposed to most other alternative investment vehicles. During recent

1 Most common investment is an Inflation Linked Note/Bond, which is commonly used as a hedge for

institutions whose liabilities fluctuate sharply with the inflation rate, but also by retail investors in order to
2 Most commonly direct investments on volatility are done with a tracker certificate, which is a zero-strike call,

on the VIX index (S&P volatility index that reflects investors consensus view on expected stock market volatility)
3 Floating coupons pay variable interest, which is tied to a benchmark rate, such as the LIBOR, EURIBOR, US T-

Bill rate, prime rate etc. In some cases, a floating coupon can have a floor, which combines it with a fixed rate. In
some special cases, a floating coupon rate can also be the difference between two rates (10 year LIBOR 2 year
LIBOR). By using floating coupons, an investor can benefit from increasing interest rates.
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years, SPs gained a strong popularity in North- and South America, but showed an even
stronger growth in Europe as well as Asia-Pacific. Within Europe, the main markets are
Germany, France, Switzerland and The Netherlands respectively (EUSIPA 2016).

Echange Turnover in Million Number of New Issues

EUR Switzerland
Austria
Austria Sweden
France
Netherlands

France

Switzerland

Sweden
Germany
Germany

Netherlands

Figure 1: Structured Products by European Country. Source: EUSIPA market reports Q1-Q4 2015

So far, the market of SPs has been studied almost exclusively from the issuers perspective,
whereby the majority of research draws on the mispricing and over-complication of SPs
(some of the most cited and renowned papers that study pricing issues are Stoimenov and
Wilkens 2005, Stoimenov and Wilkens 2007, or Breuer and Perst 2007). Aside from the
vast amount of technical research, there exist some analysis that study SPs from the retail
investors perspective, mostly by analysing behavioural aspects in investment decisions
(see Ofir & Wiener 2010, Fischer 2007, or Hens & Rieger 2009). This paper tries to
combine both aspects by applying a technical review of the SP market in Switzerland and
Germany and explaining the findings from a perspective of behavioural finance.
I designed this paper to research the different investment patterns of the two largest SP
markets in Europe, Switzerland and Germany. Based on my own experience in
Switzerland, the fundamental question I focus on is whether Swiss investors tend to buy
more risky SPs in order to achieve higher yield than German investors do.
Getting a better understanding about general investment preferences in either market is
crucial to any financial institution that operates or wishes to operate in Switzerland or
Germany. Knowing product preferences of a certain customer/target group and adapting
the product offer to the demand is fundamental in the highly competitive financial market
industry. With the fundamental goal of revealing investment patterns and customer
preferences in Europes two largest SP markets, my research aims to add value to the
target group understanding for issuers of Structured Products. Based on the achieved
insights, managers can adapt a new stance towards customer relations as well as client
acquisition. In addition, an investigation into the market of SPs that pay a coupon might
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help understanding the added value of these products, especially in the current low
interest environment in Europe. Within my paper, I will focus on Reverse Convertibles
(RC) and Barrier Reverse Convertibles (BRC), which are both structures that pay a
coupon. A RC, also known as equity-linked bond/note, consists of a Zero Bond4 and a at-
the-money short put option5, linked to (in most cases) an equity underlying (can also be
commodities). A BRC, consisting of a Zero Bond7 and a short at-the-money down-and-in
put option8, offer slightly lower yields than conventional RCs, however, they provide
partial capital protection in return. Both structures as well as its features are more
thoroughly explained in chapter 2.

1.1 Structure of this paper

Throughout this paper, I will analyse and compare the investment behaviour as well as
influencing biases of investors in Switzerland and Germany. By this, my research adds
new insights into the investment drivers of SPs that pay a coupon as well as the relating
cultural influences that trigger these drivers. I will answer the following research question
in this paper: Do Swiss investors tend to take more risky investment decisions in SPs that
pay a coupon than German investors do and what are the implied influencing factors to
these decisions? In order to thoroughly answer this question, I created 2 hypothesis: H1:
In the market of SPs that pay a coupon, Swiss investors opt for higher returns than
German investors do. H2: In the market of SPs that pay a coupon, Swiss investors add
additional product risk by picking more volatile underlyings and embedding higher
strike/barrier levels than German investors do, in order to improve the yield rate.
At the beginning of this paper, there will be a short outline about the history of SPs as
well as a detailed outline of the two structures I am researching, RCs and BRCs. This
section aims to provide a thorough understanding about how the general SP market
evolved and developed, as well as how the two structures work and how investors can
adapt it in order to achieve higher yields. As this is the major focus of this paper, it is
crucial to understand the theory first. By comparing various RCs and BRCs, I
demonstrate the effect of structuring products with more risky underlyings or basket
structures, adding a call or auto-call feature as well as shifting the barrier or BRCs.
Thereafter, I outline a review about previous literature on the topic of SPs that provided
confound insights for my research. More precisely, it introduces the findings of three
technical analyses about the mispricing and optimality of SPs as well as five studies about
behavioural finance and biases in investment decisions. The findings of both technical as

4 A Zero Bond, or Zero-Coupon Bond or Accrual Bond represents debt securities that do not pay interest but are

traded at a discount on the nominal instead. The amount of the discount depends on the prevailing interest rate
as well as on the probability of default by the issuer. At maturity, these bonds pay its full face value at par.
5 Please find the introduction to the embedded options in section 2 when Reverse Convertibles and Barrier

Reverse Convertibles are explained.

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well as behavioural analysis are crucial to my research as I take a standpoint of both
perspectives in my paper.
After introducing the data and methodology used to analyse my two hypotheses, I
conduct an analysis of more than 10,000 RCs and BRCs from Switzerland and Germany
in order to investigate whether a pattern in the risk-coupon structures can be found. The
findings in this section are crucial in order to find support for or against the hypotheses.
The data includes private placements6 as well as subscription products7. The resulting
empirical statistics are the crucial source of evidence that both of my hypotheses hold
true. Alternatively, one could conduct an experiment or survey in order to provide more
than only the predictive power of a claim, but also a proven psychological explanation
with causality. However, one has to bear in mind that experiments create artificial
situations, which in many cases cannot represent decision-making in real life situations.
Especially when it comes to investment decisions, experiments cannot deliver reliable
results in most cases due to the fact that humans naturally behave different when they
have to make decisions about their actual money, opposed to artificially created
investment decision where they do not suffer from loss. Another problem with
experimental mathematics is its staunchly methodological individualistic nature. This
means that the centre of the decision-making process remains the single individual and
external-validity may be considerably small when the sample does not reflect the entire
market, which is almost impossible (Anderson and Bloomfield 2009). Therefore, I chose a
pure financial market analysis in order to work with unbiased data that reflects an entire
market and increases the analysis external validity. Nevertheless, it entails the drawback
that it cannot establish causality.
In the last section, I draw on previous findings of behavioural finance and adapt them to
my specific case in order to explain the psychological triggers for the differences in
investment decision-making between Swiss and German investors. One of the most
crucial heuristics I analyse is Herd-Behaviour. Herding, in a sense of behavioural
finance, is a phenomenon in which investors or investment managers simply mimic the
investment decision of others and ignore substantive private information (Scharfstein and
Stein 1990). At the end of this section, I will conclude the findings of my paper and
elaborate on how further research can add additional value to the findings of this paper.

6 Private placements are products that are customized on behalf of one or more clients. No other investor can

take part in the initial investment of the product. However, they can be sold and purchased on the secondary
market.
7 Subscription products are structures that are designed by an issuer and target (especially) retail investors.

They are usually open for subscription for 5-15 trading days and are published and marketed on the issuers
website or other marketing platforms, such as newspapers or online magazines. Usually anybody who is not
restricted can purchase these products.
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2 Todays Structured Product Market
Since SPs and structured finance are broad terms, not everyone agrees completely with a
uniform definition. According to the Roberto Knops (2002), A structured product is a
complex financial instrument and its return depends on the composition of other, simpler
products. It consists of a loan, and mostly one or more derivative products. The special
feature here will be the conversion of the original risks of each of its components. He
outlines that structured products can be described in relation to their main three
components: (1) Underlying: the most commonly used asset class is equity, however, it
can also consist of fixed income, FX (currencies), commodities, rates, and more. In
addition, one has to distinguish between single underlying products from worst-of basket
(multi-asset) products. (2) Packaging: The restructuring of simple products into complex
ones follows several investment goals. These can include arbitrage opportunities, taxation
benefits, easy access to new markets, risk hedging, or optimization of a portfolios risk-
return levels with la carte created products. The packaging (terms and conditions) of
each structure has to be defined in a termsheet and needs to be signed by the investor
prior to the purchase. (3) Payoff Profile: regarding the payoff-structure, one can define
SPs in terms of six common classifications (EUSIPA 2016). A detailed outline of each of
these classifications as well as the most common products can be found in appendix 1, the
EUSIPA Map.

Capital Protection Yield Optimization Partial Protection

Products Products Products

Credit Linked Products

Leverage Products with Leverage Products with with or without
or without Knock-out constant Leverage
Participation

Figure 2: Six Classifications of Structured Products. Source: EUSIPA 2016

Figure 2 provides a good overview of the general SP market, while Figure 3 outlines all
aspects an investor is required to consider and understand when purchasing a SP. The
model is based on the different goals and purposes of structured products and aims to
provide a complete overview of all aspects that need to be taken into consideration when
investing into SPs.

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Figure 3: Classification of Structured Products.

Switzerland is the second biggest market for SPs in Europe and 7th biggest in the world.
According to the Swiss Structured Product Association (SVSP), the three most popular
products in Switzerland are (1.) Barrier Reverse Convertibles (30.5%); (2.) Tracker
Certificates (18%); and (3.) Bonus Certificates (9,9%). Since each SP follows a unique
structure and investment strategy, it would not yield much inside to analyse the aggregate
market but rather to evaluate them independently. For this reason, I chose to focus my
paper on Barrier Reverse Convertibles and Reverse Convertibles, which are both yield
enhancement products that follow a similar investment strategy. This product class is
generally implemented when a sideways trend in the market is anticipated. All yield
enhancement products are capped and have only a limited upside potential, as compared
to a direct investment. As a general rule, these kind of products provide the investor either
a coupon or bonus payment, which can be paid at a regular basis or only at maturity
(Bullet).
The next section aims to explain how Reverse Convertibles and its variation Barrier
Reverse Convertibles work. In addition, I elaborate on how investors can achieve a
certain target coupon rate by adjusting various product factors or adding optional
features. Using BNP Paribas Smart Derivatives tool, I provide real prices for each
product in order to demonstrate the effect of these adjustments and to underline the
theoretical reasoning. This section is crucial in order to understand the empirical results
of the regression in the following section.

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2.1 Reverse Convertible (RC)
A RC, or also known as equity linked note, or in Germany as Aktienanleihe, is a yield
enhancement product classified as a fixed-income security. The investor gives up a
potential upside exposure to the underlying asset in order to receive a higher coupon but
is fully exposed to the downside risk. A convertible bond allows the holder to exchange
the bonds into shares, while the holder of a Reverse Convertible is forced to convert the
notes into equity when the underlyings price falls below a certain threshold, called the
strike level (EUSIPA 2016). To compensate the risk of potential loss, the holder of a RC
benefits from a considerable higher coupon rate compared to a bond. This coupon is not
linked to the performance of the underlying and is paid in any case, except if the product
is early redeemed. A RC will outperform its underlying asset if the underlyings price does
not rise more than the coupon rate of the RC.
2.1.1 Construction
The original Reverse Convertible consists of a Zero Coupon Bond and a short put
option, mostly at-the-money. Figure 5 demonstrates the resulting payoff as an example of
a RC on the underlying Nestl with a 10% Coupon and Price of CHF 40.
The price of a RC is usually donated as a percentage of denomination instead of price per
unit. An increase of the strike price provides an investor a larger participation in the
upside performance of the underlying, however, it will also lower the coupon. Whenever
the underlyings price falls below the strike price, the option component gains in
importance while the bond character diminishes (EUSIPA 2016). The formula that
defines the payoff of a RC is:
!"#$% !" !"#$%&'(") !"#
!"#$"% !" % + min ; 1 100% !"#$%& !"
!"#$%& !"#$% !"#$ !"#$% !"#$%&
!"#$% !" % !. !. = 1 100%
!"#$!"# !"#$% !" %

Figure 4: Reverse Convertible Payoff

16
2.1.2 Payoff Scenarios
In order to explain the four possible payoff scenarios, I use the following parameters:
Denomination per certificate: EUR 1,000
Reference Price of Underlying: EUR 100
European Strike Price of short put option: EUR 100
Coupon 12% p.a. (percentage of denomination)
Conversion Ratio 1:10
Scenario 1: The price of the underlying increases and closes at EUR 150 at expiry. The
price of the RC at maturity is above the outperformance level (which is equal to the initial
price plus coupon rate) and above the break-even point for direct investments (denoted by
the payoffs x-axis interception). Under this scenario, the certificate holder receives the
coupon and the full denomination (EUR 1,120). A direct equity investment would have
yielded 50% in this situation, while the RC only yielded 12%.
Scenario 2: When the underlying performed slightly positive EUR 105 (or closed
exactly at EUR 100 at maturity) the payoff is similar to Scenario 1. However, the RC
outperformed a direct equity investment, which would have yielded only 5%.
Scenario 3: When the underlyings price falls slightly to EUR 95 (between break-even
and strike price), the investor receives the full coupon and the number of shares as
determined by the conversion ratio 10 shares per certificate. Although the underlying
performed negatively and the direct investment would have yielded a loss of 5%, the yield
of the Reverse Convertible is still 7% (12% coupon 5%).
Scenario 4: When the price of the underlying falls below the break-even point and
closes at EUR 80 at maturity, the investor receives the coupon as well as the physical
shares of the underlying. While a direct investment would mean a loss of 20%, the RC
yielded only a loss of 8%.
2.1.3 Factors influencing risk-return
The two key factors that influence the yield profile (coupon rate) are the volatility of the
underlying asset as well as the strike price. Through the additional risk of a highly volatile
underlying, the investor can profit from an increased coupon because the chances of
strike breach increase. Another feature that can be used to increase the coupon rate is the
Issuer Call option, which grants the issuer of the product to early redeem it at any early
redemption observation date. In case of an early redemption, the investor would not get
the full-expected yield as future coupons forfeit. The call feature will not be analysed in
the regression model, as the data on callable products is scarce.

17
Underlying (30 Tenor Crncy. Strike Coupon Call Total
day volatility) in years Price Period Period Coupon
SMI Index (14,40) 1 CHF 100% Bullet 4.08%
SMI Index (14,40) 1 CHF 70% Bullet 2.15%
SMI Index (14,40) 1 CHF 70% Quarterly Quarterly 2.81%
Twitter Inc. (49,90) 1 CHF 100% Bullet 15.86%
Twitter Inc. (49,90) 1 CHF 70% Bullet 6.42%
Twitter Inc. (49,90) 1 CHF 70% Quarterly Quarterly 7.59%
Table 1: Pricing of RCs with BNP Paribas Smart Derivatives tool

Components that have a slightly lesser influence on the coupon amount are the default
probability of the issuer, interest rates in the country of issuance, the tenor (time to
maturity), and the option type (American European). The default probability of an
issuer plays a role because issuers of RCs are usually also the issuers of the zero coupon
bond, which is cheaper when an issuer benefits from a strong credit rating. Additionally,
investors can construct Worst-Of Reverse Convertibles, which exist of multiple
underlyings. When not defined differently, this means that the worst performing
underlying in the basket defines the performance of the RC.
Underlying Underlying Underlying Tenor Crncy. Strike Coupon Total
(30d vola.) (30d vola.) (30d vola.) in years Price Period Coupon
SMI (14,40) 5 CHF 70% Bullet 3.01%
SMI (14,40) 1 CHF 70% Bullet 2.15%
SMI (14,40) SPX (21,30) SX5E (23.80) 1 CHF 70% Bullet 3.24%
Table 2: Pricing of RCs with BNP Paribas Smart Derivatives tool

2.2 Barrier Reverse Convertible (BRC)

A BRC is a special variation of the original RC. As the name already implies, a BRC is a
conventional RC combined with a barrier, which serves as a partial capital protection.
Since this barrier ultimately limits an investments risk, the yield is lower compared to a
RC. The denomination of the product is protected as long as the price of the underlying
or worst performing underlying (in a Basket BRC) does not fall below the barrier level,
which grants the investor less downside exposure than a RC or direct investment. A
holder of a BRC should expect a sideways moving market, but does not foreclose a
slightly decreasing underlying price. BRCs are attractive when an underlyings volatility is
expected to fall. This structure pays guaranteed coupons irrespective of the underlyings
performance, except if the product is early redeemed. Because of this, the BRC
outperforms a direct investment on the downside as well as if the underlying does not rise
by more than the coupon rate. As long as the underlying or worst performing underlying

18
does not touch the barrier, the full nominal is redeemed at maturity. When the barrier is
breached, the BRC converts into a RC.

2.2.1 Construction
A BRC consists of a zero coupon bond as well as a short down-and-in put option (usually
at-the-money). Figure 5 demonstrates the payoff of a BRC on Credit Suisse with a 10%
coupon, stock price of CHF 30 and a barrier level (knock-in threshold) at CHF 27. The
lower the barrier is set, the lower is the products implied risk is and consequently, the
lower is the yield from the structure. Different to WOF basket RCs is not only the
underlyings volatility a key driver of risk, but also the correlations between them play a
decisive role in basket BRCs. A low correlation increases the risk and return, while a high
correlation has the reverse effect.

Figure 5: Barrier Reverse Convertible Payoff

The yield function that defines the payoff of a simple BRC without any features follows
the equation:
!"#
!"#$%& !"
!"#$"% !" % + 100% !"#$ !"#$% !"#$%&
!"#$% !" % !. !. = 1 100%
!"#$!"# !"#$% !" %

For WOF BRCs, the payoff function is a bit more complicated. At maturity T, the
function can be rewritten as:

!! !
! ! = 100 100 1 !"# ! !
+ !! ,
assuming the two possible maturity events:

! = !" 0, ! , ! ! > ! ,
!! = !" 0, ! , !(!) ! ,

19
where ! = ! ! , ! 0 is a price process with j underlyings and S(0) = 100 for all j,
while B = (B1, , Bn) is a vector of barrier levels.

2.2.2 Payoff Scenarios

In order to explain the four possible payoff scenarios, I use the following initial
parameters:
Denomination in multiple: EUR 1,000
Reference Price of Underlying: EUR 100
European Strike Price of short put option: EUR 100
Coupon 10% p.a. (percentage of denomination)
Conversion Ratio 1:10
Barrier EUR 80 (American)
Scenario 1: The underlying closes above the strike price at EUR 120 at maturity. The
investor receives the full denomination plus coupon (EUR 1,100), resulting in a yield of
10% compared to a 20% yield in the direct investment.

Scenario 2: The underlying never breached the barrier and closes below the strike price
at EUR 90. As the capital protection feature of the barrier is still intact, the investor
receives the full denomination plus coupon (EUR 1,100). The BRC performed positive
with a yield of 10%, while the direct investment would have lost 10%.

Scenario 3: The underlying breached the barrier during the lifetime of the certificate
but recovered and closed above the strike price at EUR 120 on maturity. The investor
receives the denomination plus coupon (EUR 1,100), due to the underlyings positive
performance level on maturity. A direct investment would have outperformed the BRC.

Scenario 4: The underlying breached the barrier during the lifetime of the certificate
and closes below the strike price at EUR 85 on maturity. The investor receives the
coupon and the physical delivery of 10 shares of the underlying (as denoted by the
conversion ratio). Although the BRC yielded a loss of 5%, it outperformed the direct
investment.

2.2.3 Factors influencing risk-return

For BRCs, the two most important factors in order to achieve a higher coupon rate are
an underlyings volatility and the products barrier level. A more volatile underlying as
well as a high barrier level contribute to a higher risk level, thus also higher yield. A third
important influencing factor, which is however not the investors choice, is the interest
rate environment.

20
Underlying (30 Tenor in Crncy. Barrier Barrier Coupon Total
day volatility) years Level Type Frequency Coupon
SMI Index (14,40) 1 CHF 50% American Quarterly 0.41%
Twitter Inc. (49,90) 1 CHF 50% American Quarterly 4.82%
SMI Index (14,40) 1 CHF 80% American Quarterly 2.65%
Twitter Inc. (49,90) 1 CHF 80% American Quarterly 16.89%
Table 3: Pricing of BRCs with BNP Paribas Smart Derivatives tool

Alternative components to increase the risk as well as coupon level is by applying a

barrier with constant observation (American) instead of observation at maturity only
(European).

Underlying (30 Tenor in Crncy. Barrier Barrier Coupon Total

day volatility) years Level Type Frequency Coupon
SMI Index (14,40) 1 CHF 80% American Quarterly 2.65%
SMI Index (14,40) 1 CHF 80% European Quarterly 2.04%
Table 4: Pricing of RCs with BNP Paribas Smart Derivatives tool

In addition, the investor can heighten the risk-return level by adding an issuer call or
Autocall feature to the BRC. An issuer call for BRCs is similar to the feature at a RC. An
Autocall option works slightly different than an issuer call, as the BRC is automatically
early redeemed when the underlyings performance reaches a pre-defined level. In most
cases, an Autocall feature is combined with a memory coupon barrier, which further
increases a BRCs risk-return level. When the underlying closes below the coupon barrier
on any observation date, the structure will not pay a coupon. However, when on any later
observation date on which the underlying closes above the barrier, any accrued coupon
that has not been paid on a previous coupon payment dates will be refunded. Products
with these features are not included in my dataset due to the scarcity of available
information at the used sources.
Underlying (30 Tenor Crncy Barrie Issuer Autocall Coupon
Total
day volatility) years r Call Period Barrier
Coupon
Level Period
SMI Index (14,40) 1 CHF 80% Quarterly 3.52%
Twitter Inc. (49,90) 1 CHF 80% Quarterly 17.87%
SMI Index (14,40) 1 CHF 80% Quarterly 80% 3.64%
Twitter Inc. (49,90) 1 CHF 80% Quarterly 80% 19.36%
Table 5: Pricing of RCs with BNP Paribas Smart Derivatives tool

Additionally, a BRC can be structured with various underlyings in form of a Worst-Of

BRC or also called Multi BRC.
21
Underlying Underlying Underlying Tenor Crncy. Barrier Coupon Total
(30d vola.) (30d vola.) (30d vola.) years Level Period Coupon
SMI (14,40) 1 CHF 80% Quarterly 2.65%
SMI (14,40) SPX (21,30) SX5E (23.80) 1 CHF 80% Quarterly 3.59%
Table 6: Pricing of RCs with BNP Paribas Smart Derivatives tool

An investor can use and combine each of these variations in order to achieve a desired
coupon rate. However, in return for higher yield, each of these variations also entails
higher risk for potential loss. BRCs are often considered as safe havens when they are
equipped with a low barrier level, however, the chance of a barrier breach is often much
higher than it first appears. The products delta at inception can be used to get a hint for
the expected duration until the underlying breaches the barrier.

Another very important factor that influences the rate of return of both products is the
issuers aggressiveness in structuring certain products. This means that one way issuers
differentiate each other in this market is by focusing on specific structures and pricing
them extremely competitive. In addition, especially with more complex BRC structures,
Prigent (2008) found that issuers often tend to charge very high fees, which in return
negatively affect coupon rates. Since issuers do not provide information on specific
pricing strategies, they cannot be examined. As a consequence, issuer specific pricing
strategies demonstrate a drawback in my analysis. The only indication for the severity of
this variable is the error term in my regression model.

3 Literature Review
Structured Products are nowadays one of the key instruments in the financial service
industry with a total sales volume of about USD 580bn in 2015 (Alloway 2015).
Compared to 10 years before, its market size increased by about 252% globally, which
demonstrates the enormous potential of SPs (Alloway 2015). The SP market was even
stronger in 2007, shortly before the financial crisis. The reason for the long-lasting and
slow rebound is the increasingly complex regulatory environment, which evolved since
2009 in the SP market. Experts assume that the markets growth rate will increase as soon
as the issuance rate of new regulations declines and financial institutions as well as
investors face a more stable regulatory environment (Credit Suisse 5). Considering the
strong growth potential, SPs form a focal point in many academic researches. Especially
the field of pricing and mispricing has been a central interest in many papers. However,
there are not many economic analyses about the interesting role of investors portfolio
strategies and investment decision-making influences. Instead, research focused almost
exclusively on either pricing issues or certain product aspects of a specific SP.

22
3.1 Technical Literature
Burth et al. (2001) conducted a research about the pricing of 275 plain vanilla concave SP
in the Swiss market, including RCs. They compared each product with an equivalent
strategy from a different geographical market and thereby found tremendous distortions
of prices in favor of the issuers in Switzerland. Additionally, they found substantial price
differences between structures that pay a fixed coupon and those without, which was not
justified by the structure itself, meaning that structures with a fixed coupon are
considerably more mispriced than other structures. Their explanation is that fixed rate
notes/certificates are commonly issued via the fixed-income desk and the perception of a
bond-like investment might persuade investors to pay a premium. Hens and Rieger
(2008) analysed and compared the six most famous products in the German as well as
Swiss SP market in terms of their optimality in a co-monotone and strictly concave
environment and found that 4 out of 6 structures do not follow an optimal payoff
function. According to their research, investors in RCs and BRCs do not make rational
investment decisions as they deviate largely from optimality in a max utility theorem.
Instead, they explain the demand for these products with behavioural factors, like loss
aversion, hindsight bias, and herd-behaviour. Friedwald and Ruflin (2008) take a
comparable stance, however, only evaluate the pricing of WOF BRCs in the Swiss
market. They find that differences between actual market prices and benchmark prices
shrink with smaller tenors (time to maturity) as well as when the barrier has been
breached, transforming the WOF BRC into an out-of-the money RC structure. Two
more slightly less relevant but very renowned research papers on the pricing of yield
enhancement products include the two economic research articles from Stoimenov and
Wilkens (2005) and Wilkens and Stoimenov (2007), who also analysed pricing behaviour
of SPs in general from an issuers perspective.

3.2 Behavioral Literature

To my best knowledge, there has been no research that studied the investment behaviour
regarding the two most precious coupon-paying structures, RC and BRCs, from an
investors perspective. Nevertheless, there are various research papers that took a
psychological stance on investment behaviour in the SP market. Breur and Perst (2007)
apply cumulative prospect theory as well as hedonic framing to analyse investor decisions
regarding Reverse Convertibles from a bounded rationality. In their qualitative analysis,
they found that investors in RCs mostly lack in estimating the expected return of the
underlying. In addition, they also found that retail investors tend to underestimate the
implied volatility and thus, often face unexpected losses. Dbeli and Vanini (2008), use a

23
questionnaire and field experiment, to analyse that SP retail investors do not behave in
accordance with the max utility theorem. They elaborate that an attractive framing of the
product description has a far larger effect on investment decisions than a sound financial
analysis and directional view on an underlying (which are crucial for a logical and
reasonable investment decision). The interesting findings in this paper are a good starting
point for a behavioural analysis in my paper. However, one has to bear in mind that the
questionnaire included the responses of 59 bank employees only and humans tend to act
differently in experimental environments than in their natural decision-making process,
which might reduce this papers external validity. Ofir and Wiener (2010) conducted an
experiment on investment behaviour in the SP market from a rational and behavioural
choice perspective in order to analyse which biases might have the biggest impact on the
decision making process. It is concluded that the most precious behavioural biases are loss
aversion, herd behaviour, hindsight & foresight, the disposition effect, and the ostrich
effect. In this regard, the analysis of this paper adds value to my research by providing a
good understanding of the psychological factors that influence investment decisions in the
SP market. Baddeley et al. (2012) as well as Scharfstein and Stein (1990) deliver valuable
insights into the phenomenon of herding behaviour in financial markets. Both papers use
experiments in order to identify significant tendencies for individuals to follow decisions
made by many other investors (the herd). While Baddeley et al. explains their findings
with Bayesian principles, Scharftein and Stein draw on explanations from risk aversion
and sharing the blame effects. Both papers are valuable sources to better understand
herding in the financial market.

4 Data and methodology

In order to test my hypothesis, I collected a comprehensive dataset of RCs and BRCs
from both Switzerland and Germany. In this section, I elaborate on the composition of
my dataset as well as on the methods I used to collect, manipulate, and analyse the data.
Further, I will explain the methodology I used to verify the main drivers to boost return in
order to construct a well-reasoned argumentation.

4.1 The dataset

I am interested in studying risk-return patterns in the Swiss as well as German market of
RCs and BRCs. As introduced above, there are various factors and features investors can
use in order to increase their return in form of higher coupon payments. With complex
structured products, such as RCs and BRCs, investors often do not fully understand
where the additional return comes from. Therefore, I do not want to only conduct an

24
analysis of means (ANOM), but instead aim to provide a deeper insight into the root for
the deviance in coupon means between Switzerland and Germany by applying a multiple
linear regression model. By analysing whether there are certain investment patterns
within cultures as well as by testing which features are most crucial in driving risk-return
levels, I aim to provide new insights into general investment decision tendencies.

4.1.1 Methods and strategy of data gathering

The theoretical domain in my paper is defined as all Reverse Convertibles and Barrier
Reverse Convertibles that have been issued in Switzerland and Germany. This includes a
volume of about 850,000 RCs and 4,600,000 BRCs in Switzerland as well as
approximately 1,650,000 RCs and 8,100,000 BRCs in Germany
(Structuredretailproducts 2015). The investment strategies, for which yield enhancement
products are used, experienced a change in its fundamentals when interest rates sled
towards zero. While before, these products were mostly implemented for portfolio
differentiation and portfolio volatility mitigation purposes, the decrease of interest rates
led investors to use RCs and BRCs mainly to replicate bond investments, which
decreased in attractiveness due to the low interest rate environment in Europe. In order
to best analyse the purpose of this paper and to increase the validity of data, I narrow the
data population down to any product issued after 2011. This limits my population to
roughly 14% of the above-introduced total levels, as stated by EUSIPA (2016).

The Data compiled for my analysis consists of publicly available information only. The
sources used are the respective stock exchanges, Bloomberg, Reuters Datastream and
webpages of product issuers. Whenever possible, I gather the data from Bloomberg or
Datastream since it provides a large information base of readily available data, which is
considerably easy to access. Each included source gathers information directly from a
products termsheet. Working with the legally binding terms of products is crucial to the
strong validity and reliability of my dataset. Before collecting the details of each product, I
requested a list of all ISINs8 that are published at the SIX Structured Product Exchange
AG in Switzerland or at the Deutsche Brse, which combines the Frankfurt and Stuttgart
stock exchanges. Due to limitations of access rights for non-issuers, I only received a list of
6,000 ISINs from Switzerland and 8,000 ISINs from Germany for each RC and BRC
products, representing my theoretical sample. Both exchanges were not able to send me
any more detailed information about listed products. Conditionality for each entry is that
the current outstanding investment size is more than USD 300,000 (converted with the
current FX rate). This helps me to exclude products that were not attractive to investors
and thus do not represent a common investors choice. This reduced my four samples by
roughly 9-12%. According to these samples, I linked each ISIN to Bloomberg or

8 An ISIN, or International Securities Identification Number uniquely identifies a bond, commercial paper, stock,

or warrant, as defined in the act 6166 rom the International Organization for Standardization (ISO)
25
Datastream to import each products information regarding Name, Issuer, Issue Date,
Maturity Date, Coupon p.a., Coupon Frequency, Underlying(s), Initial Level(s), Strike
and/or Barrier Level(s), and 30-day volatility of each underlying at day of issuance. This
efficient data gathering process ensured me to collect the greatest possible amount of valid
and reliable information on publicly listed RCs and BRCs. Since however, not all listed
products are also published on Bloomberg, I additionally collected data directly from
termsheets on the issuers websites. This process was considerably easier in Switzerland,
as issuers seemed to be more transparent than in Germany. Nevertheless, this procedure
was extremely time consuming and inefficient. A list of all involved issuers in Switzerland
and Germany can be found in appendix 2. Whenever I consulted a products termsheet
directly, I used Bloomberg in order to get the volatility level of the underlying(s) at the
issue date.

4.1.2 Missing data and incomplete information

The quality of information differs strongly across the used sources. While the stock
exchanges failed to provide any more information than product identification numbers,
Bloomberg as well as Datastream appeared to have a high quality of information on
structures that do not have an additional feature, such as issuer call or autocall. Whenever
a product was equipped with one of the two features, both sources provided barely any
information on it. Whenever Bloomberg lacked some information, I tried to find the
termsheet online and directly retrieved the missing data from it. When the termsheet was
not available online, I deleted the entry from my sample in order to ensure completeness
of my dataset. Unfortunately, the quality of information across financial institutions
differs strongly. While some issuers provide customer with complete information, others
prove a lack of transparency or make it difficult to find the required product data. By
performing crosschecks on my dataset, I was able to verify its correctness, which is crucial
to my analysis validity. I specifically focused my checks on the parameters that are key to
perform a sound regression model. This includes the coupon rate, issue dates, strike and
barrier levels, as well as the products tenor. This process uncovered minor errors in my
set of data, which I corrected for by either consulting a products termsheet or by deleting
an entry.
4.1.3 The samples
The results of the above described data gathering and crosschecking procedures are
samples of 3,173 RCs and 3,447 BRCs from Switzerland as well as 3,433 RCs and 3,648
BRCs from Germany with all in all 157,561 data points. I excluded any structure with
issuer call, autocall or a coupon barrier9 feature due to the scarcity of data. Interestingly,

9 A coupon barrier is a pre-issue defined level at which the investor only receives a coupon when the

underlying(s) closes above the barrier on an observation date. On top to a coupon barrier, a BRC might embed a
26
it becomes directly obvious that Swiss investors tend to use more WOF basket products
than German investors. While 73% of BRCs from Switzerland have at least two
underlyings, there are only about 19% of BRCs from Germany with a basket structure.
Within the RC samples this dispersion is even bigger with 71% in the Swiss sample and
9% in the German sample.

4.2 Methodology
4.2.1 Variables in my model
For Reverse Convertibles, my default measure of risk builds on two main pillars. On the
one side, risk is defined, as the proximity of the underlyings spot price at issuance to the
defined strike price of the short put option.
Absolute Strike Level
Strike price in % =
Spot price at issue date

On the other side, a key risk factor is the underlyings volatility at the trading date.
Normally the implied volatility of the short put option would be an even better risk proxy,
however, the levels of implied volatility are unavailable without the infrastructure of a
financial institution (except for very liquid products such as indices). The difference is
that implied volatility is a measure of the markets expectations about the future volatility
of an option, while the underlyings 30 or 200 day volatility is a measure of an
underlyings historical standard deviation. For highly complex derivative structures it is
necessary to use the implied volatility to calculate the embedded risk factor, but for the
purpose of this paper it is sufficient to use the 30-day historical volatility of the underlying
as risk proxy. The historical volatility !! is a measure of the risk of price moves for a
security calculated from the standard deviation of day-to-day logarithmic historical price
changes. The method used to calculate historical volatility is described as below. First, I
calculate the return, r, for each of the 30 days prior to the issue date
!! !!!!!
!! = !!!!
,

where Si represents the spot price of the underlying on day i. Based on this, I calculate the
variance with the equation
! !!! ! !!!
!!! = !!! !!! !!!! ! !
with ! = ! !!! !!!! ,

where m=30 (the number of observations) and ! notates the mean return of the 30
observations prior to the issue date n. Since the standard deviation is usually compared

memory function, which states that once the underlying(s) closes above its barrier, the investor receives any
accrued interest from coupon payment dates at which the underlying(s) closed below the barrier.
27
on yearly volatilities (with 252 trading days), I scale the measure by calculating

!!"#$%! = 252!!! ,

where !!! is the 30 day variance prior to issue date n.

Since BRCs are commonly structured with a strike price of 100%, we use the
underlyings volatility as well as the barrier level (and type10) of the down-and-in short put
option as main risk proxies. The barrier level in % is given by:
Absolute Barrier lvl
Barrier lvl % =
Spot price at issue date

The barrier observation type is represented as a dummy variable, where 1 stands for
continuous (American) observation and 0 stands for observation at maturity only
(European). The calculation of the 30-day volatility of the underlying(s) follows the
procedure introduced above.

4.2.2 The regression model

Besides a standard analysis of means (ANOM), I will perform a multi linear regression
model. Before defining its conditions and terms of the model, I test my data for
multicollinearity, heteroscedasticity, and outliers.
Multicollinearity refers to the phenomenon that the used predictor variables
(Strike/Barrier Level and Underlying 30 day Volatility at issue date) are highly correlated
and can linearly predict each other with a substantial degree of accuracy. In the presence
of multicollinearity, the overall predictive power of the regression model would not be
reduced, however, it limits the validity and reliability to determine individual predictors.
Statistically, my two predictor variables, Strike/Barrier Levels (X1) and 30-day volatility
levels (X2) would be perfectly multicollinear if a linear relationship among them exists.
This condition holds if we find the parameters ! ! and ! ! such that for all observations i
we find
!!! = ! ! + ! ! !!! .
This can be statistically tested by calculating the variance inflation factor (VIF), where the
tolerance is defined as:
!
tolerance = 1 R!! and VIF = !"#$%&'($,

with R!! being the coefficient of determination of predictor j. As a general rule,

multicollinearity is likely if VIF>3 and definitely exists if VIF>5. Running this with my
dataset yields that multicollinearity can be precluded as shown in table 7.

10 American, end-of-day, or European barrier observation

28
 Collinearity Coefficients

RC BRC
Switzerland Germany Switzerland Germany
Vola. Strike Vola. Strike Vola. Barrier Vola. Barrier

Tolerance .948 .948 .976 .976 .814 .695 .786 .949

VIF 1.055 1.055 1.024 1.024 1.229 1.439 1.273 1.053

Table 7: Collinearity Coefficients

Heteroscedasticity can be defined as a condition in which the variability of a variable

is unequal across the range of values of a second variable that predicts it (White 1980).
The presence of heteroscedasticity in a dataset implies that the Gauss-Markov theorem
cannot be applied and that ordinary-least-squares estimators will not provide exact
estimators of linearity. This would ultimately mean that the regression model provides an
unbiased estimate for the relationship of variables but it will bias estimates of standard
errors, likely yielding to a type 2 error. The statistical test used to verify whether
heteroscedasticity applies to our dataset is the White test. H0 for this test states that
homoscedasticity, or no heteroscedasticity exist. The standard linear regression model
used in this paper is
Y! = ! + ! X!" + ! X!" + ! .
Following, I obtain the squared residuals on the original independent variables X1 and
X2, the squared independent variables X!! and X!! as well as the cross-product of the two
independent variables X1X2 and perform a regression, yielding
! !
Y! = ! + ! X!" + ! X!" + ! X!" + ! X!" + ! X!" X!" .
Based on this auxiliary regressions R2 value, I test the models statistical significance of
!
nR! ~ X!" ,
where df defines the amount of regressors. The corresponding results imply that H0 is
rejected and heteroscedasticity is present in each sample, as illustrated in table 8.
Therefore, a logistic regression cannot be applied. However, a multi linear regression
model can be used without concern of serious distortion, as long as the heteroscedasticity
is not severe (White 1980). Nevertheless, the existing heteroscedasticity implies that one
has to critically evaluate the regressions standard errors and confidence intervals.

29
 White Test Results
Sum of Squares df Mean Square F Sig
Regression 130726.051 2 65363.025 797.323 0.000
Switzerland Residual 259788.513 3169 81.978
Total 390514.564 3172
RC
Regression 34369.383 2 17198.192 157.383 0.000
Germany Residual 374708.026 3429 109.276
Total 409104.409 3431
Regression 28004.735 2 14002.367 129.903 0.000
Switzerland Residual 370583.898 3445 107.791
Total 398588.633 3447
BRC
Regression 101908.829 2 16998.140 148.638 0.000
Germany Residual 362342.734 3646 109.021
Total 464251.563 3648
Table 8: White test for heteroscedasticity results

Outliers can demonstrate a serious problem in the multi linear regression model and
distort its statistical results. Outliers are data points that diverge largely from the overall
pattern in observations. These individual points, if present, can indicate faulty
observations. If not corrected for extreme outliers, the correlation coefficients might be
unjustifiably skewed and the line of best fit might be distort. Therefore, I carefully
analysed each extreme outlier that has been identified by the means of an interquartile
range rule multiplier of 3. The method used to identify these outliers is a box and whisker
plot combined with a stem and leaf analysis of the corresponding data.

After controlling for multicollinearity, heteroscedasticity, and correcting each sample for
outliers, I ensure that a multiple linear regression model can be performed without biases.
Since I exclude the issuer call and autocall features from my model, I will test a single
response measurement Y! by means of two predictor variables X! (strike/barrier level) and
X! (max 30 day volatility of the underlyings at issue date) for each observation i.

The fundamental assumption for my model is a linear relationship, defined as

E(Y! |X) = ! + ! X!" + ! X!" + ! ,
where ! is the intercept, ! / ! are the slope coefficients and ! defines the models error
term. In order to estimate , I implement a least squares analysis, by minimizing
!
! Y! ! ! X!,! ! X!,! ,
which is minimized by setting
= X!X !! !
X Y,
30
where X ! X !! and XX are p + 1 x p + 1 symmetric matrices and X ! Y is a
p + 1 dimensional vector (Williams 2016). Then the fitted values are defined by
Y = X = X X ! X !!
XY
and the residuals are
r = Y Y = I X X!X !! !
X Y.
Consequently, the standard deviation can be calculated by

! !!!
= (!!!!!)
.

5 Empirical Results
In this section, I will show and discuss the findings obtained by the ANOM and
regression model. In addition, I will use a behavioural finance approach in order to
interpret the meaning of these results. This stance is crucial in order to explain my results
because both an ANOM and regression model only yield the predictive power of
variables but fail to provide insights into the what, how, and why of investment decisions
from a human perspective. Therefore, an analysis from the perspective of heuristics is
necessary. Heuristics are mental shortcuts to simplify situations in which investors often
suffer from cognitive biases. This means that their thought and decision making process
deviates from logic probability or rationality in judgment, whereby inferences about
situations may be created based on illogical fashion.

5.1 ANOM evaluation
After correcting for outliers, I constructed histograms for each individual variable in each
data set. Figures 6-11 show the histograms for Reverse Convertibles and the figures 12-17
show the histograms for Barrier Reverse Convertibles. For each set of histograms, the
upper three charts depict the Swiss sample while the lower three charts illustrate the
variables from German products. The descriptive statistics for each separate variable are
outlined in the below ANOM table (Table 9), which is the first statistical analysis I used in
order to find the distinctive differences between RCs and BRCs from Switzerland (CH)
and Germany (DE).







31
 Analysis of Means

95% Confidence
Interval
Std.
Mean UCD LCD Median Deviation Min Max Skewness Kurtosis
Cpn. 7.17 (.05) 7.27 7.08 7 2.71 1 25 1.37 (.04) 4.14 (.09)
CH Vola. 30.67 (.29) 31.25 30.09 27 16.55 5.71 150 1.68 (.04) 4.38 (.09)
Strike 62.68 (.17) 63.02 62.33 64 9.86 29 100 -.06 (.04) .007 (.09)
RC
Cpn. 6.20 (.05) 6.29 6.11 6 2.751 1 19 1.05 (.04) 1.53 (.08)
DE Vola. 24.52 (.18) 24.85 24.18 22 10.06 7 76 1.28 (.04) 3.01 (.08)
Strike 86.86 (.15) 87.15 86.56 89 8.82 44 96 -1.14 (.04) 3.05 (.08)
Cpn. 7.22 (.04) 7.31 7.12 7 2.72 1 25 1.29 (.04) 4.16 (.08)
CH Vola. 30.03 (.32) 30.66 29.40 26 18.83 4.28 135 1.63(.04) 3.48 (.08)
Barrier 63.35 (.16) 63.66 63.37 65 9.09 35 90 -.152 (.04) -.221 (.08)
BRC
Cpn. 6.45 (.03) 6.52 6.39 7 1.98 1 17.6 .262 (.04) .715 (.08)
DE Vola. 25.65 (.26) 26.17 25.13 23 14.33 7 127 1.68 (.05) 5.99 (.09)
Barrier 63.99 (.16) 64.29 63.69 65 8.68 30 96 -121 (.04) .34 (.08)
Table 9: ANOM (Analysis of Means) descriptives. All values are based on the before introduced sample. Extreme
outliers, when present, have been excluded when they were not justified, e.g. an extreme deviation in a volatility
data point is only excluded if it could not be justified by a comparably higher coupon rate and lower
strike/barrier level. Cpn. stands for a products coupon rate and Vola. represents the 30-day volatility level of an
underlying at issue date (or the highest 30 day volatility level of the underlyings in a basket at issue date).


5.1.1 Reverse Convertibles the first six histograms
Already by comparing the standalone ANOM values of the coupon variables from RCs
issued in Switzerland and Germany, it becomes clear that Swiss products comprise on
average a higher yield of almost 1% (in absolute terms). Considering that both have a
similar standard error of 0.05, this is already a supportive indicator that on average Swiss
investors tend to demand RCs with higher coupons, assuming that the sample is driven
by demand. The histograms for the coupon variables demonstrate that most of the RCs
from Switzerland have a coupon of 6.5% to 7.4% (used for about 550 products), while the
mostly used coupon for German RCs ranges from 4.5% to 5.4% (used for about 700
products). In addition, the highest identified coupon for Swiss RCs is by 6% (in absolute
terms) higher than the maximum coupon variable found in the German sample. Both
histograms of coupons have a right skew, however, the skewness is by 32 points larger for
the Swiss sample, meaning that the higher coupon values from Switzerland spread across
a wider value span than those from Germany do. Analysing the coupon rates as a
standalone variable gives us a good indication about the general division in risk-return
between Switzerland and Germany, but it cannot explain where the evaluated yield
pattern comes from. Incorporating the other two variables helps to shed some light on
this uncertainty as well as provides an interesting insight into the difference between the
two markets.

32
The sample of Swiss RCs shows a mean 30-day volatility level that is 6% (in absolute
terms) higher than the mean volatility level from German products. In addition, a
significant fact is that the maximum volatility level from the Swiss RC sample is almost
twice as high as the same value from the German sample. Further, the distribution curve
for the Swiss sample is 40 points more positively skewed than the distribution curve of the
German sample. Without taking the strike level into consideration, this indicates that the
higher yield in Swiss RCs might be explained by the on average 6% higher 30-day
volatility of the underlying at issue date. However, when accounting for the Strike level,
the tide is turning. German RCs have on average a strike level that is 24% (in absolute
terms) higher than the mean strike level used in Switzerland. Taking a look at the
histograms below clearly shows that the German RC sample is extremely non-linear with
a negative skew of -1.14 that can be clearly explained by the extreme peak at 95%, which
is implemented in 972 products (28.3134% of the collective sample for German RCs).
Interestingly, the mean volatility for these 972 products is considerably low at 13.48%,
which might justify the high strike price. One might assume that structures with a high
strike price pay a coupon rate comparable of a product that includes an underlying with a
high 30-day volatility level, but surprisingly, the average coupon rate of the 972 RCs is
6.37% only, while e.g. products with an underlyings 30-day volatility level of 35% have a
mean strike level of 60% but pay on average a coupon of 8.55%. The risk level of both
examples is roughly the same, but the effect on the coupon rate of a high underlyings
volatility is considerably stronger than the effect of a high strike level.

This phenomenon has been already explored before by pricing three RCs with similar
parameters except that one has a strike level of 70%, the second a strike level of 95%
(both with the SMI Index with a 30 day volatility of 14.4%), and the third is priced with a
strike level of 70% but on a more volatile underlying (Twitter with a 30 day volatility of
49.22%). While the original example paid a coupon of 1.16%, the second example with a
higher strike level paid a coupon of 4.16%. Pricing the same structure with a considerably
more volatile underlying yielded a coupon level of 7.13%11. This short example illustrates
that the underlyings volatility has a considerably stronger weighting on the valuation of a
RC than the strike level. In addition, it might explain the difference in the mean coupon
rate between Switzerland and Germany. The following multiple linear regression models
help to further analyse how much weight (predictive power) each of the two independent
variables have on a products coupon rate.

11 All three prices are priced with BNP Paribas online trading platform smart derivatives, which gives live

tradeable prices on structured products. The 30 day volatility levels are extracted from Bloomberg.
33
 Pearson Correlation Analysis
Cpn. Vola. Strike / Barrier
Cpn. 1.000 .661 .068
Switzerland Vola. .661 1.000 -.228
Strike .068 -.228 1.000
RC
Cpn. 1.000 .282 .360
Germany Vola. .282 1.000 -.155
Strike .360 -.155 1.000
Cpn. 1.000 .584 .012
Switzerland Vola. .584 1.000 -.336
Barrier .012 -.336 1.00
BRC
Cpn. 1.000 .383 .181
Germany Vola. .383 1.000 -.159
Barrier .181 -.159 1.000
Table 10: Pearson Correlation Analysis of the variables. Again, Cpn. refers to the
coupon rate of a product and Vola. is the underlyings 30-day volatility level at issue
date.

Table 10 demonstrates the Pearson Correlations between each variable. It clearly

underlines the theory that the underlyings volatility level has a stronger positive relation
on the coupon rate in the Swiss sample than it does in the German sample. In addition, it
illustrates that the relationship between strike level and coupon rate is considerably
stronger in the German RC sample, while it is close to zero for Swiss RCs.

5.1.2 Barrier Reverse Convertibles the second six histograms

The analysis of means for the two BRC samples yielded a comparable but still slightly
different picture than the ANOM evaluation of RCs. The mean coupon of Swiss BRCs is
0.77% (in absolute terms) higher than the average coupon rate from German products.
While for both samples, a coupon rate of 7% not only displays the mean value but also
the mostly used yield rate. Nevertheless, an explanation for the difference in means can
be drawn from the skewness of the histogram. While the Swiss sample contains an
extremely large positive skew, the German sample is close to a normal distribution,
meaning that German samples aggregate around the mean rather than spreading over a
large span of above mean values. The overall finding about the mean coupon rate is
similar to the result in the RC sample and strengthens the support for the introduced
hypothesis. In addition, obtaining a homogeneous tendency of outputs in two separate
tests with independent samples strengthens the reliability and validity of results.

Different to the average strike levels of the RC samples, the mean barrier levels of Swiss
and German BRCs are fairly similar at 63.35% and 63.99% respectively. This result is

34
overall not surprising to me, as the general investment strategy of BRCs is to obtain above
average fixed-income yields by simultaneously protecting the invested capital from loss
opposed to RCs for which the strategy is to obtain above average yields in a sideways
moving market. Therefore, if an investor has the clear view that a certain underlying will
perform flat over a certain period, he or she will definitely use a RC to earn the additional
yield in for an underlying that does not attract a direct investment, assuming rationality.
However, for BRCs the investors often have a weaker or more uncertain outlook on the
market. This can be assumed because BRCs provide the investor partial capital
protection, which increases confidence when one has no direct view on an underlyings
expected performance. A lower barrier enables investors to gain a larger negative
performance span for which the denomination is protected and thereby provides investors
a stronger confidence to gain high yields for low risk, which is the fundamental idea of a
BRC.

Interestingly, the correlation analysis shows that although the overall barrier level means
are fairly similar across the two samples, the relationship with the coupon rate is similar.
While the coupon of Swiss products is only slightly correlated with the barrier level, the
same relationship in the German sample is considerably stronger. This could mean that
holding all other variables constant, the barrier level in Germany has more weight on the
valuation of the coupon rate than it does in Switzerland. The same conclusion can be
drawn by incorporating the regression results, which I will do in the next section. On the
other hand, the mean 30-day volatility level of underlyings is again higher for Swiss
products, justifying the difference in coupon rates. Interestingly however, is that the
difference of mean coupon rates in the BRC samples is slightly smaller than in the RC
samples although the barrier level does not function as a counter pressure on the coupon
gap between Switzerland and Germany, such as the higher strike level did before. This
could be seen as an indicator that the weightings of each variable in the pricing model of
BRCs deviates from the equation used to value RCs. The following statistical output of
the multiple linear regression analysis aims to help in order to explain this phenomenon
further by quantifying the predictive power of each variable on a products coupon rate.

35
 REVERSE CONVERTIBLES (Figures 6-11)
VOLATILITY STRIKE COUPON

BARRIER REVERSE CONVERTIBLES (Figures 12-17)

VOLATILITY BARRIER COUPON

36
5.2 Statistical Descriptives
In this section of the paper, I will elaborate on the outputs of the regression model. The
analysis of means clearly showed that both RCs and BRCs from Switzerland have on
average higher coupon rates as a result of implementing more volatile underlyings. Since
the previous analysis fails to grasp the interconnected effects of each variable on the
coupon rate, this section is crucial to get a deeper insight into the interplay that drives
risk-return levels of RCs and BRCs. Table 11 is a summary of the most important
regression values from each of the four models. The intercept values !! are not reported
because it is of less interest and only carries significance in cases where both independent
variables !! and !! can become equal or close to zero, which is not the case for our
variables.
Regression Estimates
Coefficients Model Summary
Beta Std. Error t-values Sig. R R2 Std. Error
Vola. .117 .002 54.517 .000
Switzerland .698 .487 1.941
Strike .063 .004 17.630 .000
RC
Vola. .094 .004 23.035 .000
Germany .668 .446 2.388
Strike .129 .005 27.574 .000
Vola. .166 .004 30.150 .000
Switzerland .706 .498 2.072
Barrier .035 .005 2.118 .034
BRC
Vola. .058 .012 5.106 .000
Germany .641 .412 .2413
Barrier .060 .016 3.964 .000
Table 11: Output of the four multiple linear regression models. The applied significance level is 95%. The beta
coefficient and the respective standard error refer to unstandardized coefficient values. The stated R2 values refer to the
adjusted R2 values, which corrected for the number of predictor variables, although the dispersion between the original
and adjusted term are only very small.

A striking finding that underlines previous assumptions is the dispersion of the two
independent variables predictive powers on coupon rates between Switzerland and
Germany. As already investigated in the analysis of means, coupon rates of products
issued in Switzerland are rather driven by the 30-day volatility levels of its underlying(s),
while those for German products have a stronger positive relationship with Strike/
Barrier Levels. While this difference exists across RC and BRC samples, the gap of the
dispersion is much larger for the latter. Furthermore, at a 95% significance level, the
p-values from each variable across all four samples are below .001 except for the Barrier
Level of Swiss BRCs, which is .035. Therefore, I can already conclude that all variables
are statistically significant at the 95% threshold level. I already expected this result due to
the large sample size, which makes it imperative to further analyse individual regressions
results.

37
5.2.1 The Swiss Samples
Considering Swiss products only, it is interesting that against the assumptions drawn from
the analysis of mean an underlyings 30-day volatility levels predictive power is 29%
lower for the RC sample than for the BRC sample. Precisely, the rate of change of the
conditional mean of the coupon rate with respect to an increase of 1% in the underlyings
30-day volatility level (while holding all other levels constant) is between .113 and .121 for
RCs or between .158 and .174 for BRCs. Considering to implement an underlying with a
volatility of 40% instead of 10%, which is definitely common in the market, a RCs
coupon rate could statistically increase by 3.65%, while for BRCs it could even be a yield
raise of 5.22%. On the contrary, the effect of a RCs Strike Level has a larger effect on the
coupon rate than Barrier Levels do in BRC structures. Assuming all other variables are
constant, an increase of 30% in the Strike Level of a product will result in a maximum
change of 2.13% of the coupon rate of an RC, while it would increase a BRCs yield by
1.34% only, demonstrating the different importance of each variable when targeting a
high coupon rate.

5.2.2 The German Samples

In both German samples the picture turns, as the predictive power of the Strike/Barrier
level is stronger than the predictive power of an underlyings 30-day volatility level. In
addition, coupon rates of BRCs climb considerably slower with each increase in the two
independent variables than it does for RCs, which might be reasonable considering the
decreased risk, investors are exposed to with a barrier structure. This might at appear to
make not much sense because one might expect that issuers in two markets so close to
each other should use similar pricing models. However, it seems that pricing strategies are
fundamentally different in the two markets, or lets put it differently, one might assume
that investors in Germany demand fundamentally different structures than investors in
Switzerland and issuers simply filled the demand. In addition, an interesting aspect of the
regression model for the German BRC sample is the comparably large standard
deviation. The margins of error for an underlyings 30-day volatility level and the barrier
level is .0235 and .0314 respectively, which is approximately three times as high as the
standard deviations of the other slope coefficients.

5.2.3 R2 and the error term

Strikingly, for each of the four samples, there is still more than 50% of the variance in the
coupon rate, that cannot be predicted by the variance of the Strike/Barrier Level and the
underlyings 30-day volatility level. This is rather surprising, since theory would suggest
that the combination of the two variables is the key determinant of a products (RC as
well as BRC) coupon rate. However, an aspect that most theory does not cover but on
38
which academic research strongly focuses on is the issuers aggressiveness to market and
sell certain structures as well as its effect on the structures price. This is crucial because
price is directly interconnected with the yield of a product and issuers certainly rather try
to increase prices than paying higher yields. Burth et al. (2001) as well as Hens and Rieger
(2008) concluded in their papers on mispricing patterns that an issuers differentiation by
focusing on certain product structures has on average an even stronger predictive power
on a structures price than the original theoretical principles. Nevertheless, this effect is
something that cannot be estimated with 100% certainty, as in the end the pricing
formula is an issuers technical crme de la crme, which no financial institution would
publicize. This might pinpoint at the probably biggest problem in the structured product
market the complexity and intransparency of issuers. In order to help investors
understand the market and product structures better, behavioural finance theory suggests
that they use heuristics, which are mental shortcuts, in order to simplify situations that
demand to make a decision, often leading to cognitive biases. In order to better
understand this connection between psychological biases and investment decisions in RCs
and BRCs, I will use two principles to explain how these heuristics shape the market.

6 Herding as a heuristic a decision making shortcut

Herding, in a sense of behavioral finance, is a phenomenon in which investors or
investment managers simply mimic the investment decision of others and ignore
substantive private information. From a social standpoint, this decision-making strategy
might appear inefficient, however, it contains rationality whenever investors are
concerned about their reputation (Scharfstein and Stein 1990). The resulting justification
investors use in such situations to perceive their mistake as acceptable is the share-the-
blame effect. Further Scharfstein and Stein conclude that by following the herd, an
investor bypasses the risk of being perceived as irrational and dumb when making an
unprofitable investment that is contrary to the belief of the herd. The group or network
influence in many investment decisions is in line with the bounded rationality theory
introduced by Keynes. This implies that whenever an investor is confronted with a
situation where rationality is bounded by cognitive and informational constraints as well
as entails large probability of fallible judgment, which could ultimately lead to a loss, it
might appear rational to rely on potentially better-informed investors and follow them
(Keynes 1930, 1936, 1937).

Leibenstein (1950) provided a rather different underlying reasoning for herding behavior
than Scharfstein and Stein did. He argues that herding is a phenomenon that illustrates a
humans desire to be fashionable or stylish and conform those investors they wish to be
associated with. While Scharfstein and Steins argumentation rather applies to
39
professional investment managers for which reputation is the key, Leibensteins definition
might be very well adaptable to the retail investment sector. In addition, Katz and
Saphiro (1985) developed the theory of the network effect, which can be seen as another
reason that investors suffer from the herding heuristic. This theory states that the value
that an investor derives from an investment is dependent on the number of other users
that hold the same asset (that are in the same network). This argumentation makes sense
in the terms of investment behavior because if the demand for a certain product
increases, so does its price. On the contrary, if a vast amount of investors sell (short) a
product, the price of the product will decrease. The crucial assumption Katz and Saphiro
make with regard the network effect is the existence of complete information. In a market
of imperfect information, Bikhchandani, Hirschleifer, and Welch (1992) established the
theory that herd behavior occurs whenever investors observe the investment behavior of
banks and larger financial institutions in order to derive investment decisions without
regard to ones own information. This includes for example the recommendations from
certain institutions as well as online portals etc., which are common under non-
professional investors. The underlying assumption for investors following this theory is
that the observed investors hold more information on market conditions or have more
experience in deriving sound investment decisions.

6.1 Signs and evidence for herding in the Swiss markets

During the previous empirical evaluation of investment patterns in the Swiss RC and
BRC market, I found that Swiss investors tend to demand higher coupons as opposed to
German investors. Since the statistical tests are unable to explain why Swiss investors tend
to demand higher yields, this section aims to provide some theoretical insights and
explanations from the standpoint of herd-behavior. This heuristic has been well
researched in the context of behavioral finance and appears to explain best where the
specific investment trend comes from. On the one side, I argue that the crucial drivers are
highly professional and skilled investors that serve as role models for inexperienced
investors as well as investment managers. On the other side, I explain the role that issuers
play in triggering herd behavior. Precisely, I chose four typical examples in the Swiss
market and combine them with empirical findings on herd-behavior in order to
demonstrate how herding influences the Swiss market.

1) The first perspective that supports the existence of herding in the Swiss RC and BRC
market is the products complexity, which is not easily understandable for any
investor, especially non-institutional ones. On top of product complexity, investors are
exposed to the complexity of the general financial markets as well as macro-
economical events, which add to the uncertainty an investor faces before making a
40
 decision. Park and Sabourian (2011) found in their paper that whenever the average
investor is confronted with a more complex system, it is more likely that investors,
even professional ones, act against their own information. The additional complexity
creates insecurity about making investment decisions, because the decision-maker is
aware that the likelihood of making a wrong call becomes larger. Consequently, the
more uncertain environment and more volatile markets limit the availability and
reliability of information and might impose bounded rationality on investors in the
complicated SP market. In such situations, it could appear rational for an investor to
rely on the decisions of investors, who are perceived to have insider knowledge or
simply a more certain standpoint on the performance of a security, making herding
more likely and in some situations even rational (Park and Sgroi 2016). Assuming that
these more knowledgeable investors are professional investors with insider knowledge,
the likelihood of an investment in a more volatile underlying appears more likely.
Consequently, following these professional investors implies a herding trend for
products that entail an above average yield rate due to the higher volatility of
underlyings, contributing to the results of the analysis of means.

2) As already elaborated previously in this paper, the general market of SP that pay a
coupon experienced a tremendous increase in popularity within the current low
interest rate environments. While the bond market decreased in attractiveness, BRCs
in Switzerland became a new investment trend. Until 2012, Tracker Certificates were
the top-selling SPs in Switzerland, but BRCs took the lead with a total share of 30.5%
of the CHF 235 billion SP market in Switzerland (SVSP 2016). Considering the
fashionable status of BRCs in Switzerland and the fact that the first trendsetters were
large institutional clients such as funds and asset managers, it appears reasonable to
include the findings of Leibenstein (1950). He proved that herding is a common
behavior in fast growing but complex markets, because investors feel the need to be
fashionable and innovative by participating in the trend. Since they might not have
the necessary knowledge and understanding to comfortably make a rational decision,
they follow the actions of more advanced investors. In his research, Leibenstein also
acknowledges that in most cases, the follower tries to replicate the investment of
somebody they wish to be associated with. Following and trusting in the actions of a
role model seems like a logical link, which can also be observed in many other
situations when one is confronted with reaching a decision under uncertainty or
inability. The two underlying psychological theories for this phenomenon are
Salomon Aschs conformity bias, in particular the associated type identification
conformity, as well as the theory of Information Cascades (Bikhchandani,
Hirschleifer, and Welch 1992) (Kelman 1958). Similar to the first perspective,
professional investment managers and fund accountants can be expected to have

41
 insider knowledge on positions, making it more likely that they invest in products that
entail higher risk and return. For this reason, the herding effect might favor to the
results of the regression analysis.

3) In general, the Swiss culture is considered to be one of the most conservative and
formal cultures in Europe (Blatter 2015). In Switzerlands financial world, which
includes one of the oldest and most prestigious banking sectors, personal reputation is
a necessity to be acknowledged as a successful investment manager. This trend dates
back to the golden ages of the investment sector in Switzerland, where success was
almost seen as a norm and mistakes were indefensible (Blatter 2015). This importance
of personal reputation of investment managers can be seen as a drive of herding
behavior, as analyzed by Scharfstein and Stein (1990). Their theory applies especially
to investors that act in the interest of others, such as professional asset managers, or
investment consultants in banks. This theory is in alignment with Keynes bounded
rationality theory, in which he explains that professional money managers tend to
mimic other investors whenever they are worried that their ability to make decisions is
assessed. This theory can be assumed to find additional attractiveness if either the
market environment contains uncertainty or in the presence of a trend. Moreover, by
following the herd, investment managers can mitigate the risk of being considered
irrational. This means that whenever a manager follows the investment behavior of
the herd, he or she is very likely not to be considered irrational, but rather unlucky.
This phenomenon can be explained by the attribution theory in which actions
according to the conformity of the group, in which everybody of the group observed a
piece of the same truth and acted upon it, favors to attribute the mistake to external
forces, such as bad luck, rather than to the person itself (internal). On the other side, if
an investor would take a bet against the standpoint of the herd, resulting in an
unprofitable investment, he or she would be considered to act irrational and dumb
(Shiller 1995). Even if the investor made a rational decision based on facts, it could
weaken his or her reputation due to the non-conformity with the herd.

4) Besides the supportive perspectives of investor behavior on herding, issuers of RCs

and BRCs seem to play a key role of triggering this heuristic in the Swiss market.
When analyzing the publicly offered subscription products of the five largest financial
institutions in Switzerland (UBS, Credit Suisse, Vontobel, Julius Baer, Leonteq), there
appears to be a certain amount of similarity across underlyings of RC and BRCs
across the issuers. On average each of the analyzed institution offers 9 BRCs and 4
RCs. In total, 43% of the implemented underlyings can be found in the subscription
product offer of at least 2 banks and 36% in the offer at least 3 banks. This clearly
implies that issuers of RCs and BRCs drive herding behavior by providing retail

42
 investors similar opportunities. This similarity might trick inexperienced investors in
the perception that the most advertised underlyings must be the most promising ones,
taking that they have no special market or insider knowledge. The reason behind the
similarities might be the fact that the Swiss SP market is highly competitive and
issuers do not want to risk loosing a client because a rival offers a more attractive
product. By advertising products with similar underlyings across institutions, issuers
are able to attract retail clients towards certain products. This theory can be
combined with the findings of Burth et al. (2001) and Hens and Rieger (2008) who
found that issuers make higher returns when structuring and selling more complex
and more risky products. This means that e.g. with a callable BRC, an issuer can
charge higher fees than with a RC entailing a blue-chip stock as underlying.
Therefore, it appears reasonable to believe that issuers who want to gain maximum
return advertise more complex and riskier products, which ultimately enforces
herding in products with a higher coupon.

6.2 Recommendations to validate my findings

In order to establish clear causality as well as a strong empirical evidence for the
relationship between herding and yield hunting, it is crucial to conduct an experiment.
The most valuable type of experiment in order to assess an investors real reaction to
information is a field experiment. A laboratory experiment would not be able to reliably
evaluate an investors behavior since it cannot replicate the importance of making the
right investment decision or the negative effects of coming to an unprofitable decision.
Therefore, a field analysis can best portray and assess the psychological backgrounds that
coincide when making investment decisions. In addition, such experiment could also test
for other heuristics and biases (availability, representativeness, anchoring, hindsight bias,
or overconfidence) that might play a crucial role in explaining the high-yield investment
trend.

On top, further research could focus on a neuroeconomical analysis in order to study how
the brain reacts in certain situations that trigger herding. This could help in
understanding why certain people act according to herd-behavior as well as how this
heuristic stimulates specific brain cells that consequently trigger a reaction. Functional
magnetic resonance imaging tests (fMRI) in an experimental environment could yield
these insights, however, as explained before, the drawbacks of an artificially created
investment situation remain.

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7 Conclusion
I designed this paper to research the different investment patterns of the two largest SP
markets in Europe, Switzerland and Germany. The question I am trying to answer is
whether Swiss investors tend to take more risky investment decisions in SPs that pay a
coupon than German investors do. In addition, I am interested to find the implied
influencing factors to these decisions patterns. Getting a better understanding about
general investment preferences in either market is of great practical interest to any
financial institution that operates or wishes to operate in the structured product market of
Switzerland or Germany. The market of RCs and BRCs is especially important, because
investors use these structures in order to mimic bond investments, which do not embed
attractive yield opportunities in the current low-interest rate environment.
I collected data of more than 13,000 RCs and BRCs in order to empirically test the
validity of my hypothesis. By the means of an analysis of means (ANOM), I found that the
average coupon of Reverse Convertibles from Switzerland is 0.97% per year higher than
the yield from a German RC. A similar result has also been found for the BRC market.
This clearly suggests that Swiss investors tend to demand products with higher coupons
than German investors, assuming that supply is demand driven. In addition, it becomes
apparent that the main drivers for higher coupons are different between the two
countries. While in Switzerland, underlyings with a high volatility level are the main
source of improving a products yield, the ANOM suggests that the coupons of German
products is rather driven by higher strike- and barrier levels. This result has also been
confirmed by the slope coefficients of the multiple linear regression analysis of each
sample.
Theory of structured products suggests that the underlyings volatility level and the
strike/barrier levels are the main influencing factors of a RCs or BRCs yield. However,
the regression clearly illustrated that more than 50% of the variation in each of the
coupon levels cannot be explained by the variation in the two main influencing factors. It
can be assumed that this is because an aspect that most theory does not cover, but on
which academic research strongly focuses on, is the issuers aggressiveness to market and
sell certain structures as well as the resulting effect on the structures valuation. Burth et al.
(2001) as well as Hens and Rieger (2008) concluded in their papers on mispricing patterns
that an issuers differentiation by focusing on certain product structures has on average an
even stronger predictive power on a structures price than the products features
(strike/barrier, issuer call, autocall, etc.).
Based on the empirical findings that Swiss investors tend to buy Reverse Convertibles and
Barrier Reverse Convertibles with a higher risk as well as yield levels, I draw on the
insights of behavioural finance in order to explain the driver for this investment pattern.
More specifically, I show that herd-behaviour plays a crucial role in driving up the
44
countrys average yield preference. I link RC and BRC market specific situations to some
of the most renowned herding principles and theories and demonstrate four factors that
imply herding and play a crucial role in driving above average coupon rates in
Switzerland: (1) herding as a result of being overwhelmed by the product and market
complexity, (2) herding as a result of conformity in the trendy BRC market, (3) herding as
a result of sharing the blame and attribution theory, and (4) herding as a result of issuers
push strategies to sell more profitable structures. Leibenstein (1950) observed that
followers mostly try to mimic the actions of somebody they wish to be associated with.
Since bond investments are rather unattractive, many of the high performing investors
and fund managers in Switzerland use BRCs to imitate high yield bonds. Due to the high
amount of quality information these professional investors have or are expected to have,
they often serve as role models in the first three scenarios.

45
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9 Appendix
9.1 Appendix 1:
EUSIPA map of structured product with explanations of classifications

48
SETIPA
2VDCHRG$WBG@MFD
3Q@CDC(MUDRSLDMS
/QNCTBSR RRNBH@SHNM

2VDCHRG$WBG@MFD3Q@CDC
(MUDRSLDMS/QNCTBSR RRNBH@SHNM

SETIPA
SETIPA 2VDCHRG$WBG@MFD3Q@CDC
(MUDRSLDMS/QNCTBSR RRNBH@SHNM

SETIPA
2VDCHRG$WBG@MFD3Q@CDC(MUDRSLDMS/QNCTBSR RRNBH@SHNM
9.3 Appendix 2:
List of included issuers in each country

Switzerland Germany
1 Bank J Safra Sarasin AG/Guernsey Bayerische Landesbank
2 Bank Julius Baer & Co Ltd/Guernsey BNP Emission und Handelsgesellschaft
3 Banque Cantonale Vaudoise Commerzbank AG
4 BCV Guernsey Dekabank Deutsche Giro
5 BNP Paribas Deutsche Bank AG
6 Corner Banca SA Deutsche Bank AG London
7 Credit Suisse AG/London DZ Bank AG
8 Credit Suisse AG/Nassau Goldman Sachs & CO Wertpapiere
9 Goldman Sachs HSBC Trinkhaus+Burkhardt
10 Julius Baer HSH Nordbank AG
11 LEHMAN BROS FINANCE SA KFW
12 Leonteq Securities AG Landesbank Hessen-Thueringen
13 Notenstein La Roche Private Bank AG LB Baden-Wuerttemberg
14 Raiffeisen Schweiz Genossenschaft Norddeutsche Landesbank
15 Societe Generale Societe Generale Effektenbank
16 UBS AG/London UNICREDIT Bank AG
17 UBS AG/Nassau Vontobel Finanz Produkte Deutschland
18 Vontobel
19 Zricher Kantonalbank

50