Exchange-traded Fund Market Research Articles

Exchange Traded Fund Flows

I investigate the flow-return relationship in Exchange Traded Funds (ETFs). A variable for fund flows is defined using the change in shares outstanding, and the correlation and causality between ETF fund flows and returns is investigated at individual and aggregate levels. Significant negative correlation is documented between ETF flows and market returns, in monthly frequency. Investigating the nature of the association, I fail to reject the hypothesis of no-price-pressure on market returns originating from ETF flows. Higher frequency investigation of the relation indicates return chasing behavior in some ETFs, and is inconclusive in others.

Basket Securities, Price Formation, and Informational Efficiency

This paper investigates the role of basket securities in the efficient price formation process of individual component securities. The study focuses on one type of basket security, exchange traded funds (ETFs), which includes some of the most actively traded securities in the U.S. equity market. A multi-asset variance decomposition methodology is developed to measure the information contributions of the return and trade innovations of ETFs. The results show that a substantial amount of the information incorporated into the efficient price of a component stock originates in the ETF market. More interestingly, ETF trades are found to have permanent impacts on component stock prices. An analysis of ETF introductions reveals that both informational efficiency and market liquidity of the component stocks improve after the ETF starts trading. The findings suggest that seemingly redundant securities can have important informational functions.

Island Goes Dark: Transparency, Fragmentation, Liquidity Externalities, and Multimarket Regulation

In response to a regulatory enforcement, the Island electronic communications network recently stopped displaying its limit order book in the three most active exchange-traded funds (ETFs). As a result of this reduction in pre-trade transparency, this dominant venue's share of trading activity and price discovery falls, fragmenting the market. ETF prices adjust more slowly when Island goes dark, and substantial price discovery moves from the ETF market to the futures market. Island's effective and realized spreads increase, while effective and realized spreads fall in other markets. The increase in spreads on Island more than offsets the reduction in trading costs in other markets, increasing overall trading costs. Overall ETF market quality falls.