Speed of Convergence to Market Efficiency in the ETFs Market
Managerial Finance, Vol. 39, No. 5, pp. 457-475, 2013
Posted: 30 Mar 2012 Last revised: 21 Apr 2013
Date Written: April 18, 2013
We examine the informational efficiency of prices of all exchange traded funds (ETFs) that are actively traded on the NYSE Arca, based on methodology developed by Chordia et al. (2005), and compare the resulting price formation process to that of shares traded on the NYSE and NYSE Arca. Despite the significant differences in trading costs, volatility, and informational effects between ETFs and regular stocks, we document that price adjustments to new information for ETFs occur in about thirty minutes, which is comparable to price adjustments for traditional stocks traded on Arca. In multivariate setting, we further show that the speed of convergence to market efficiency of ETFs is not only significantly driven by volume, but also by the probability of informed trading. Our analysis of the speed of convergence provides a feasible measure to assess how efficiently prices of ETFs respond to new information. We are first to utilize the short-horizon return predictability from historical order flow approach to evaluate the price formation process of ETFs and to provide evidence on the determinants of its efficiency.
Keywords: ETFs, Price formation, Speed, Market efficiency, Liquidity, NYSE Arca
JEL Classification: G10, G14
Suggested Citation: Suggested Citation