Liquidity and Risk Sharing Benefits from Opening an ETF Market with Liquidity Providers: Evidence from the CAC 40 Index
Posted: 12 Sep 2008 Last revised: 16 Dec 2014
Date Written: April 28, 2014
This article examines how the introduction of an ETF replicating a stock index impacts on the liquidity of the underlying stocks when the ETF market involves liquidity providers (LPs). We find that index stock spreads decline, relative to those of non-index stocks, after the introduction of the ETF but this liquidity improvement is not driven by changes in adverse selection costs or recognition effects. By contrast, we show that it is mainly explained by a decrease in order processing and order imbalance costs. This most probably results from additional risk sharing capacities provided by increased cross-market trading and LPs’ liquidity provision in low-liquidity times.
Keywords: Exchange-traded fund (ETF), index trading, transaction costs, liquidity, risk sharing
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation