ETFs, Learning, and Information in Stock Prices

Abstract

This paper studies how the introduction of ETFs, and the growth of ETF ownership, can change investors' learning behavior. I develop a rational-expectations model where agents decide (1) whether they want to become informed or not and (2) if informed, how to allocate their limited attention between learning about individual stocks and a systematic risk-factor. Introducing an ETF does not universally increase or decrease learning about systematic risk. If the volatility of the systematic risk-factor is large, risk aversion is high, or the cost of becoming informed is high, introducing the ETF leads investors to devote more attention to the systematic risk-factor. Otherwise, the ETF may lead investors investors to learn more about the individual stocks. I decompose the effect of introducing the ETF into 2 channels: (1) Changes in the share of agents who decide to become informed (2) Re-allocation of attention among informed investors. I then extend the model, allowing an intermediary to buy the underlying stocks and create more shares of the ETF. Finally, I link the model's predictions to empirical evidence on the growth of ETF ownership and less informative stock prices.