Exchange-Traded Funds and Municipal Bond Market

Abstract

This paper studies the effect of exchange-traded funds' (ETFs) daily holding disclosure on the pre-trade transparency of municipal bond markets. Bonds held by ETFs have significantly smaller price dispersion than similar, non-ETF-held bonds. The relation holds when I exploit a plausibly exogenous variation in ETF disclosure quality, and is stronger for retail trades, on bonds associated with high uncertainty and in stressed markets, suggesting investors benefit more when information is scarce. I further document lower dealers' markup and inventory imbalance in markets of ETF-held bonds - an indication of higher customers' bargaining power resulting from improved transparency. ETF effects also spillover to the primary market, as when a municipality has outstanding bonds held by ETFs, its newly issued bonds have higher valuation and lower price dispersion. Overall, my findings indicate that ETF information disclosure is an important channel through which investors can gain additional insight into the pricing of municipal bonds.