Brazilian Exchange Traded Funds (ETFs) Pricing Efficiency: Long Term Analysis Based on Cointegration with Markov Regime Switching

Abstract

Exchanged Traded Funds (ETFs) are a wide-spread investment vehicle, with characteristics that have not been sufficiently studied yet, especially in emerging markets. Consolidated asset pricing models are not enough to thoroughly analyze the dynamics of share prices variation and their relationship with net asset value and the market, a special feature of investment funds with exchange traded shares. The objective of this study is to analyze the pricing efficiency of Brazilian ETFs, based on the long-term relationship between share prices and the market index, as well as share prices and the ETFs net asset value (NAV). We estimated the cointegration with Markov regime switching between Brazilian ETFs share prices and Ibovespa index and the cointegration between Brazilian ETFs share prices and their NAV, analyzing their long-term behavior during the 2004-2012 range. The error term generated by the cointegration is analogous to the traditional measures of pricing deviation. Our results pointed that the error term of the first estimation is stationary, but the second is not, indicating that the share prices and the NAV are not in fact cointegrated. Considering that during crisis periods the ETFs trade at discounts, but they are cointegrated with the market in the long run, there may be arbitrage opportunities that the investors could take benefit, buying the ETFs in crisis periods and selling them after that the market recovers.