Charles A. Dice Center Working Paper No. 2011-20
110 Pages Posted: 2 Dec 2011 Last revised: 27 Mar 2017
Date Written: March 1, 2017
Due to their low trading costs, ETFs are likely to be a catalyst for short-horizon liquidity traders. The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the non-fundamental volatility of the securities in their baskets. We exploit exogenous changes in index membership and find that stocks with higher ETF ownership display significantly higher volatility. Demand for ETFs increases the negative autocorrelation in stock prices. The increase in volatility appears to introduce undiversifiable risk in prices, because stocks with high ETF ownership earn a significant risk premium of up to 56 basis points monthly.
Keywords: ETFs, volatility, arbitrage, fund flows
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation
Ben-David, Itzhak and Franzoni, Francesco A. and Moussawi, Rabih, Do ETFs Increase Volatility? (March 1, 2017). 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