Exchange-Traded Funds, Fails-to-Deliver, and Market Volatility

70 Pages Posted: 1 Dec 2012 Last revised: 5 Nov 2013

See all articles by Thomas Stratmann

Thomas Stratmann

George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute)

John W. Welborn

Dartmouth College

Date Written: November 30, 2012

Abstract

Exchange-traded fund (ETF) trading volumes have increased over the last decade and so have ETF settlement failures at the clearing corporation. We test the hypothesis that ETF short selling, high stock borrow prices, and options contract expiration contribute to ETF fails-to-deliver (FTDs). We document a positive relationship between net daily ETF settlement failures and daily ETF short sale volume, the cost to borrow ETFs, and quarterly index options expiration dates (so-called “triple witching” dates). These findings are not consistent with the claim that fails are random. Rather, these findings are consistent with the hypothesis that market makers fail to deliver to avoid paying borrowing costs associated with their short sales. Further support for this hypothesis comes from a positive correlation between ETF FTDs and ETF put option open interest. Finally, we show that ETF settlement failures are important for the functioning of markets because they impact market index volatility. We find that positive changes in aggregate ETF FTDs Granger-cause higher market index volatility. We attribute this causality to buying and borrowing of common stock shares by market makers in order to close-out ETF FTD positions by trade date plus six days (“T 6”). We conclude that ETF FTDs are not inconsequential for market stability.

Keywords: exchange-traded funds, short selling, fails-to-deliver, volatility

JEL Classification: G14, G18, G28

Suggested Citation

Stratmann, Thomas and Welborn, John W., Exchange-Traded Funds, Fails-to-Deliver, and Market Volatility (November 30, 2012). GMU Working Paper in Economics No. 12-59. Available at SSRN: https://ssrn.com/abstract=2183251 or http://dx.doi.org/10.2139/ssrn.2183251

Thomas Stratmann (Contact Author)

George Mason University - Buchanan Center Political Economy ( email )

4400 University Drive
Fairfax, VA 22030
United States
703-993-2330 (Phone)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

John W. Welborn

Dartmouth College ( email )

Department of Economics
Hanover, NH 03755
United States

HOME PAGE: http://https://www.dartmouth.edu/pep/

Register to save articles to
your library

Register

Paper statistics

Downloads
662
Abstract Views
3,532
rank
37,982
PlumX Metrics