ETFs, High-Frequency Trading and Flash Crashes
Posted: 21 Jul 2016 Last revised: 14 Nov 2016
Date Written: July 18, 2016
In this article, the author presents a model of distributional properties of returns on financial instruments tied to ETFs via high-frequency statistical arbitrage. As the author’s model shows, the securities subject to an ETF arbitrage exhibit a well-defined behavior, largely dependent on the behavior of other securities comprising the ETF. The model can be used to improve risk management of long-term portfolios, and, in particular, allow hedging of flash crashes. Furthermore, the analysis shows that in the electronic markets that allow high-frequency trading, the intraday downward volatility for the underlying securities comprising an ETF is bounded from below, and, is, as a result, less extreme than that of securities not included in any ETFs. Also, in the markets where the high-frequency trading is restricted, downward price movements are more extreme than in the markets where high-frequency trading is present.
Keywords: Portfolio Management, Volatility, Risk Management, Risk Measurement, ETFs, High-Frequency Trading, Flash Crashes, Mathematical Models
JEL Classification: C01, C02, D01, D44, D84, D81, G11, G12, G15, G18
Suggested Citation: Suggested Citation