A Four-Trillion-Dollar Question: Why Trade ETFs Instead of Their Underlying Stocks?

53 Pages Posted: 16 Mar 2012 Last revised: 8 Feb 2024

See all articles by Wenxi Jiang

Wenxi Jiang

CUHK Business School, The Chinese University of Hong Kong

Ruikun Wang

The Chinese University of Hong Kong (CUHK)

Hongjun Yan

DePaul University

Date Written: November 8, 2023

Abstract

One potential answer is that, according to information-based theories, ETFs should be more liquid than their underlying stocks. However, this prediction does not hold for around 90% of US-equity ETFs, a four-trillion-dollar market. We hypothesize that investors value ETFs’ convenience, for which, our estimate shows, they pay 37 bps of market capitalization per annum. Consistent with our hypothesis, convenience costs are higher when there are a priori reasons for higher demand or costlier supply for convenience. Finally, larger ETFs tend to have lower convenience costs, which may help them grow even larger, leading to a fat-right-tailed size distribution among ETFs.

Keywords: Financial Innovation, ETF, Information Sensitivity, Convenience, Speculation, Leverage.

JEL Classification: G11, G23

Suggested Citation

Jiang, Wenxi and Wang, Ruikun and Yan, Hongjun, A Four-Trillion-Dollar Question: Why Trade ETFs Instead of Their Underlying Stocks? (November 8, 2023). Available at SSRN: https://ssrn.com/abstract=2023142 or http://dx.doi.org/10.2139/ssrn.2023142

Wenxi Jiang

CUHK Business School, The Chinese University of Hong Kong ( email )

Room 1210, Cheng Yu Tung Building
Chinese University of Hong Kong
Shatin, NT 06520
Hong Kong

HOME PAGE: http://https://sites.google.com/site/jiangwenxi/

Ruikun Wang

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Hongjun Yan (Contact Author)

DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/hongjunyanhomepage/

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