Abstract

http://ssrn.com/abstract=2023142
 
 

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Financial Innovation, Investor Behavior, and Arbitrage: Implications from Levered ETFs


Wenxi Jiang


Yale University - School of Management

Hongjun Yan


Yale University - International Center for Finance

November 18, 2012


Abstract:     
In the light of standard theories of financial innovation, levered ETFs are unusual in that although they are largely marketed to retail investors, they increase, rather than decrease, information sensitivity. How does this affect market liquidity? Controlling for the underlying index, the turnover in the levered ETF market is several times higher than that in the regular ETF market. However, this does not imply that the levered ETF market is more liquid, as we also find that levered ETFs have significantly higher bid-ask spreads and lower liquidity ratios. One interpretation is that levered ETFs appeal certain type of investors who are interested in short-term levered speculation or hedging. In aggregate, the total cost levered ETF investors incur is around 5% of the market capitalization, or around $1 billion, each year. Moreover, levered and regular ETF investors appear trade differently: For levered (regular) ETFs, monthly fund flows are strongly negatively (positively) correlated with both current and past month returns. Finally, due to limits of arbitrage, ETF prices converge to their fundamental values, but only gradually.

Number of Pages in PDF File: 31

Keywords: Financial Innovation, Leverage, Investor behavior, Index.

JEL Classification: G11, G23

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Date posted: March 16, 2012 ; Last revised: April 17, 2013

Suggested Citation

Jiang, Wenxi and Yan, Hongjun, Financial Innovation, Investor Behavior, and Arbitrage: Implications from Levered ETFs (November 18, 2012). Available at SSRN: http://ssrn.com/abstract=2023142 or http://dx.doi.org/10.2139/ssrn.2023142

Contact Information

Wenxi Jiang
Yale University - School of Management ( email )
New Haven, CT 06520
United States
Hongjun Yan (Contact Author)
Yale University - International Center for Finance ( email )
Box 208200
New Haven, CT 06520
United States
HOME PAGE: http://faculty.som.yale.edu/hongjunyan/

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