Do ETFs Increase Volatility?

62 Pages Posted: 2 Dec 2011 Last revised: 14 Oct 2014

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department; National Bureau of Economic Research (NBER)

Francesco A. Franzoni

Università della Svizzera italiana (USI), Lugano; Swiss Finance Institute

Rabih Moussawi

Villanova University - Department of Finance; University of Pennsylvania - The Wharton School

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2014

Abstract

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.

Keywords: ETFs, volatility, arbitrage, fund flows

JEL Classification: G12, G14, G15

Suggested Citation

Ben-David, Itzhak and Franzoni, Francesco A. and Moussawi, Rabih, Do ETFs Increase Volatility? (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. Available at SSRN: https://ssrn.com/abstract=1967599 or http://dx.doi.org/10.2139/ssrn.1967599

Itzhak Ben-David (Contact Author)

Ohio State University - Fisher College of Business, Finance Department ( email )

2100 Neil Avenue
Fisher 700D
Columbus, OH 43210-1144
United States
773 988 1353 (Phone)

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Francesco A. Franzoni

Università della Svizzera italiana (USI), Lugano ( email )

Via G. Buffi 13
Lugano, 6904
Switzerland

Swiss Finance Institute

Switzerland

Rabih Moussawi

Villanova University - Department of Finance ( email )

800 E Lancaster Ave
Bartley Hall, 1003
Villanova, PA 19085
United States

University of Pennsylvania - The Wharton School ( email )

United States

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