ETF Flows and Underlying Stock Returns: The True Cost of NAV-Based Trading

28 Pages Posted: 23 Feb 2016 Last revised: 15 Mar 2016

See all articles by Friedrich Osterhoff

Friedrich Osterhoff

Technische Universität München (TUM) - Department of Financial Management and Capital Markets

Maximilian Overkott

Technische Universität München (TUM) - Department of Financial Management and Capital Markets

Date Written: March 7, 2016

Abstract

In this paper, we examine whether the creation or redemption ETF shares has a measurable and significant effect on the underlying stocks’ returns in the closing auction. Our findings show that ETF flow-related stock transactions significantly affect stock prices. We provide empirical evidence showing that creations/redemptions of ETFs that replicate indices in the German DAX index family have a highly significant and economically viable effect on abnormal returns of underlying stocks in the closing auction an effect that is particularly pronounced in small stocks and on bullish trading days. We argue that, given the sizable additional annual earnings of up to € 53,000 per stock, the AP has a motivation to exploit this inefficiency, by means of active price manipulation during the closing auction. Hence, dealing in ETF shares on the primary market, for example through NAV-based orders, might entail hidden costs for investors that, until now, have not been recognised in the literature and perhaps not even by investment professionals.

Keywords: ETF, Exchange-traded fund, Fund flows, Trading volume, Asset basket, Asset pricing

JEL Classification: G12, G14, G15, G23

Suggested Citation

Osterhoff, Friedrich and Overkott, Maximilian, ETF Flows and Underlying Stock Returns: The True Cost of NAV-Based Trading (March 7, 2016). Available at SSRN: https://ssrn.com/abstract=2736392 or http://dx.doi.org/10.2139/ssrn.2736392

Friedrich Osterhoff

Technische Universität München (TUM) - Department of Financial Management and Capital Markets ( email )

Munich, 80333
Germany

Maximilian Overkott (Contact Author)

Technische Universität München (TUM) - Department of Financial Management and Capital Markets ( email )

Munich, 80333
Germany

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