Do ETFs Increase Volatility?
Ohio State University - Fisher College of Business, Finance Department; National Bureau of Economic Research (NBER)
Francesco A. Franzoni
University of Lugano; Swiss Finance Institute
University of Pennsylvania - The Wharton School
June 17, 2014
Charles A. Dice Center Working Paper No. 2011-20
Fisher College of Business Working Paper No. 2011-03-20
Swiss Finance Institute Research Paper No. 11-66
AFA 2013 San Diego Meetings Paper
A long-lasting debate in finance centers on the impact of derivatives on the efficiency of prices of the underlying securities. The paper contributes to this literature by studying whether exchange traded funds (ETFs) — an asset of rising importance — affect the non-fundamental volatility of the stocks in their baskets. Using identification strategies based on the mechanical variation in ETF ownership, including regression discontinuity, we show that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. Variance-ratio tests, as well as price reversals, suggest that the mean-reverting component of stock prices is inflated by ETF ownership. We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 19% in intraday stock volatility. The driving channel appears to be arbitrage activity which propagates liquidity shocks from the ETF market to the underlying stocks.
Number of Pages in PDF File: 59
Keywords: ETFs, stocks, volatility, mispricing, fund flow
JEL Classification: G12, G14, G15working papers series
Date posted: December 2, 2011 ; Last revised: June 18, 2014
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