When the Bellwether Dances to Noise: Evidence from Exchange-Traded Funds
University of Notre Dame - Mendoza College of Business
University of Notre Dame - Department of Finance
August 1, 2013
We provide novel evidence that arbitrageurs can exacerbate return comovement via ETF arbitrage. Using a large sample of U.S. equity ETF holdings, we nd a strong relation between measures of ETF activity and return comovement at both the fund and the stock levels, after controlling for a host of variables and fixed eftects. The effect is stronger among small and illiquid stocks and during market turbulence. An examination of delay measures and mutual-fund-flow-induced price pressure suggests that at least some ETF-driven return comovement is excessive. In other words, ETFs may reduce diversication, the very benet they were designed to facilitate.
Number of Pages in PDF File: 47
Keywords: exchange-traded funds, correlation
JEL Classification: G14, G23
Date posted: October 8, 2012 ; Last revised: August 6, 2013
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