A Three-Trillion-Dollar Question: Why Trade ETFs Instead of Their Underlying Assets?

46 Pages Posted: 16 Mar 2012 Last revised: 29 Oct 2021

See all articles by Wenxi Jiang

Wenxi Jiang

CUHK Business School, The Chinese University of Hong Kong

Yaqing Xiao

Capital University of Economics and Business

Hongjun Yan

DePaul University

Date Written: October 28, 2021

Abstract

One potential answer is that, according to information-based theories, ETFs should be more liquid than their underlying assets. However, this prediction does not hold for over 90% of US-equity ETFs. We propose a “convenience” hypothesis: investors trade ETFs partly for convenience, for which, we estimate, they pay an annual intermediation cost of over 2% of market capitalization. Consistent with our hypothesis, the measured intermediation cost is indeed larger when there are a priori reasons to expect larger convenience; that is, when the underlying index is more volatile, an index reconstitution is approaching, or the ETF provides embedded leverage.

Keywords: Financial Innovation, ETF, Information Sensitivity, Convenience, Speculation, Leverage.

JEL Classification: G11, G23

Suggested Citation

Jiang, Wenxi and Xiao, Yaqing and Yan, Hongjun, A Three-Trillion-Dollar Question: Why Trade ETFs Instead of Their Underlying Assets? (October 28, 2021). Available at SSRN: https://ssrn.com/abstract=2023142 or http://dx.doi.org/10.2139/ssrn.2023142

Wenxi Jiang

CUHK Business School, The Chinese University of Hong Kong ( email )

Room 1250, Cheng Yu Tung Building
Chinese University of Hong Kong
Shatin, NT 06520
Hong Kong

Yaqing Xiao

Capital University of Economics and Business ( email )

Beijing
China

Hongjun Yan (Contact Author)

DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/hongjunyanhomepage/

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