Locally-Capped Investment Products and the Retail Investor

Locally-capped products are an economically important and poorly understood category of structured financial products. These contracts combine a guaranteed payoff with a bonus equal to some accumulation of the capped periodic returns of a reference portfolio. We show that these products often contain unreasonably optimistic hypothetical scenarios in their prospectuses, and conjecture that these unrealistic hypothetical scenarios may contribute to the popularity of these products. We use the Black and Scholes model to show that locally-capped products perform poorly in turbulent markets and that currently available products were overpriced by an average of 6.5% when they were sold to the public