Abstract
This paper employs Hasbrouck’s (2003) information share method to analyze the flow of information in equity markets. In particular we compare trading in Index ETFs with that of their underlying securities. Surprisingly, ETFs seem to play a significant role in the price discovery process, rather than serving as passive indexing/hedging vehicles. Using TAQ data we reconstruct the second-by-second intraday price series for the S&P 500 using its component stocks. Results show that the ETF contributes almost half to the price formation of the spot S&P 500. Next, comparing trades and quotes, we determine the relative amount of informed trading (versus noise) in the ETF. When trading in the ETFs is driven more by private information, the ETF contributes more to price discovery. Thus, the evidence suggests that a significant portion of ETF trading is information motivated.
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