Tracking Errors and Their Determinants: Evidence from Hong Kong Exchange Traded Funds

Abstract

This paper extends the author’s previous study on the magnitude of tracking error, which used panel data to find the determinants of tracking errors in exchange traded funds (ETFs) in the Hong Kong stock market. In general, the results of this study suggest that tracking errors are comparatively greater in Hong Kong ETFs than in ETFs in the U.S. and Australia. A comparison of tracking errors between physical and synthetic ETFs also indicates that the synthetic ETFs have higher tracking errors. The magnitude of tracking errors is found to be negatively related to size but positively related to dividend yield, trading volumes of funds, and market risk. This finding is consistent with those of previous studies. However, this study also finds that expense ratio has a negative impact on tracking error, which is not consistent with previous studies, and which this paper addresses.