Do ETFs Increase Volatility?
Due to their low trading costs, exchange-traded funds (ETFs) are a potential catalyst for short-horizon liquidity traders. The liquidity shocks can propagate to the under-lying securities through the arbitrage channel, and ETFs may increase the nonfundamental volatility of the securities in their ba...
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| Published in: | The Journal of finance (New York) Vol. 73; no. 6; pp. 2471 - 2535 |
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| Main Authors: | , , |
| Format: | Journal Article |
| Language: | English |
| Published: |
Cambridge
Wiley Periodicals, Inc
01.12.2018
Blackwell Publishers Inc |
| Subjects: | |
| ISSN: | 0022-1082, 1540-6261 |
| Online Access: | Get full text |
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| Summary: | Due to their low trading costs, exchange-traded funds (ETFs) are a potential catalyst for short-horizon liquidity traders. The liquidity shocks can propagate to the under-lying securities through the arbitrage channel, and ETFs may increase the nonfundamental volatility of the securities in their baskets. We exploit exogenous changes in index membership and find that stocks with higher ETF ownership display significantly higher volatility. ETF ownership increases the negative autocorrelation in stock prices. The increase in volatility appears to introduce undiversifiable risk in prices because stocks with high ETF ownership earn a significant risk premium of up to 56 basis points monthly. |
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| Bibliography: | Itzhak Ben‐David is with the Fisher College of Business, The Ohio State University, and NBER. Francesco Franzoni is with Università della Svizzera italiana (USI) Lugano and the Swiss Finance Institute. Rabih Moussawi is with the Villanova School of Business, Villanova University, and Wharton Research Data Services (WRDS) at the Wharton School, the University of Pennsylvania. We are especially grateful to Andrew Ellul, Marco Di Maggio, Robin Greenwood (AFA discussant), and Martin Oehmke (NBER discussant). We thank Pierre Collin‐Dufresne; Chris Downing; Vincent Fardeau; Thierry Foucault; Rik Frehen; Denys Glushkov; Jungsuk Han; Johan Hombert; Augustin Landier; David Mann; Rodolfo Martell; Massimo Massa; Albert Menkveld; Robert Nestor; Marco Pagano; Ludovic Phalippou; Anton Tonev; Tugkan Tuzun; Dimitri Vayanos; Scott Williamson; Hongjun Yan; and participants at seminars and conferences at the NBER Summer Institute (Asset Pricing), Toulouse School of Economics, Insead, HEC Paris, the Cambridge Judge Business School, Villanova University, USI Lugano, the 4th Paris Hedge Funds Conference, the 5th Paul Woolley Conference (London School of Economics), the 8th Csef‐IGIER Symposium (Capri), the 5th Erasmus Liquidity Conference (Rotterdam), the 1st Luxembourg Asset Pricing Summit, the Center for Financial Policy Conference at the University of Maryland, Jacobs Levy's Quantitative Financial Research Conference at the Wharton School, the Geneva Conference on Liquidity and Arbitrage, the 20th Annual Conference of the Multinational Finance Society, the 7th Rothschild Caesarea Conference, the Swedish House of Finance, the FIRS conference (Toronto), and SAC Capital Advisors for helpful comments and suggestions. Ben‐David acknowledges support from the Neil Klatskin Chair in Finance and Real Estate and from the Dice Center at the Fisher College of Business. Franzoni acknowledges support from the Swiss Finance Institute. An earlier version of this paper circulated under the title “ETFs, Arbitrage, and Shock Propagation.” The authors do not have any material disclosure to make. ObjectType-Article-1 SourceType-Scholarly Journals-1 ObjectType-Feature-2 content type line 14 |
| ISSN: | 0022-1082 1540-6261 |
| DOI: | 10.1111/jofi.12727 |