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Underlying Valuation Uncertainty, Strategic ETF Creation and Pricing Efficiency
89 Pages Posted: 16 Dec 2024 Last revised: 2 Nov 2025
Date Written: November 18, 2024
Abstract
This paper identifies a novel mechanism through which uncertainty in corporate bond valuation shapes the creation process of corporate bond ETFs. Although multiple ETFs can potentially accept the same bond during the “in-kind” creation process, they often value it differently. Such valuation dispersion is driven by fund pricing conventions and external pricing sources, but can also reflect ETFs’ efforts to minimize tracking error. Authorized Participants (APs) exploit these differences by delivering a bond to create the ETF that values it most highly. While this strategic behavior increases APs’ profits, it dilutes holdings of incumbent investors and undermines ETF pricing efficiency.
Keywords: corporate bond, creation basket, authorized participant, liquidity, valuation dispersion, ETF, price efficiency
Suggested Citation: Suggested Citation
Huang, Alan G. and Wermers, Russell R. and Xue, Jinming and Zhou, Xing (Alex),
Underlying Valuation Uncertainty, Strategic ETF Creation and Pricing Efficiency
(November 18, 2024). SMU Cox School of Business Research Paper No. 24-17, Available at SSRN: https://ssrn.com/abstract=5046012 or http://dx.doi.org/10.2139/ssrn.5046012
Jinming Xue (Contact Author)
Southern Methodist University (SMU) - Finance Department ( email )
United States
(214)-768-4181 (Phone)
HOME PAGE: http://sites.google.com/view/jinming-xue
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