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
October 1, 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
An ongoing 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 increasing 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. Our evidence suggests that ETFs attract a new layer of demand shocks to the stock market due to their high liquidity.
Number of Pages in PDF File: 62
Keywords: ETFs, volatility, arbitrage, fund flows
JEL Classification: G12, G14, G15
Date posted: December 2, 2011 ; Last revised: October 14, 2014
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