How Index Futures and ETFs Affect Stock Return Correlations

53 Pages Posted: 21 Jun 2015 Last revised: 24 Aug 2016

Markus Leippold

University of Zurich - Department of Banking and Finance; University of Zurich - Faculty of Economics, Business Administration and Information Technology

Lujing Su

University of Zurich - Department of Banking and Finance

Alexandre Ziegler

University of Zurich - Department of Banking and Finance

Date Written: April 24, 2016

Abstract

We examine both theoretically and empirically whether increased trading activity in index futures and exchange traded funds (ETFs) is associated with higher equity return correlations. Our model predicts that demand shocks to ETFs and futures lead to stronger price comovement for index stocks and non-index stocks. Moreover, demand shocks to ETFs have a higher impact on stock return correlations than shocks to futures. We confirm the model predictions by studying the correlation of U.S. stocks after the inception of S&P 500 futures and ETFs. Furthermore, our empirical results suggest that the return comovement induced by index trading is excessive.

Keywords: Asset correlations, limits to arbitrage, ETFs, futures

JEL Classification: G01, G12, G13

Suggested Citation

Leippold, Markus and Su, Lujing and Ziegler, Alexandre, How Index Futures and ETFs Affect Stock Return Correlations (April 24, 2016). Available at SSRN: https://ssrn.com/abstract=2620955 or http://dx.doi.org/10.2139/ssrn.2620955

Markus Leippold (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

University of Zurich - Faculty of Economics, Business Administration and Information Technology ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

Lujing Su

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Alexandre Ziegler

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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