Can ETFs Increase Market Fragility? Effect of Information Linkages in ETF Markets

55 Pages Posted: 4 Mar 2016 Last revised: 27 Apr 2018

Ayan Bhattacharya

Baruch College, The City University of New York

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: April 17, 2018

Abstract

Exchange traded funds (ETFs) have a novel design that allows them to “open up” illiquid markets hitherto resistant to index products. We demonstrate that such ETFs also have the potential to alter the informational efficiency of underlying markets and introduce fragility via herding. Specifically, while these ETFs bring more information to the markets at the aggregate level, individual asset prices may face persistent dislocations. We also show that such ETFs can exacerbate herding, where speculators across markets trade similarly, unhinged from fundamental value. All results arise from the distinct characteristics of inter-market learning in ETFs on hard-to-access underlying settings.

Keywords: ETF, Market stability, Learning, Market fragility, Herding, Market microstructure

JEL Classification: G14, D47, D82

Suggested Citation

Bhattacharya, Ayan and O'Hara, Maureen, Can ETFs Increase Market Fragility? Effect of Information Linkages in ETF Markets (April 17, 2018). Available at SSRN: https://ssrn.com/abstract=2740699 or http://dx.doi.org/10.2139/ssrn.2740699

Ayan Bhattacharya (Contact Author)

Baruch College, The City University of New York ( email )

New York, NY 10010
United States

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

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