Pricing Efficiency & Performance of Exchange Traded Funds in India

Abstract

Exchange Traded Funds are a remarkable example of financial innovation that provides the investors with unique inherent feature of a mutual fund and an ordinary corporate stock. The present study is motivated by the need to examine the performance, index tracking capabilities and pricing efficiency of ETFs. The purpose of the study is to address three objectives; (i) do the ETFs fully replicate the returns of the underlying benchmark, (ii) is there any pricing deviation between trading price and NAV of the respective ETFs studied and (iii) the magnitude and persistence of premium/discounts in the market. The results of regression show that selected Indian ETFs do not follow full replication strategies and beta estimates deviate from unity with statistically insignificant alpha. Due to imperfect tracking ability of ETFs, there is presence of tracking error with significant magnitude. The difference between market price and NAV of ETF reveal presence of discount (excess of NAV over market price) and pricing inefficiencies. The premium/discount persist in the market for an average period of three days but exceptional persistence of five days was observed for two ETFs.

Keywords: Exchange Traded Funds, Tracking Error, Performance, Pricing Deviation, Premium

JEL Classification: C-22, G-12, G-23