ETF Flows, Non-Fundamental Demand, and Return Predictability
50 Pages Posted: 21 Nov 2016 Last revised: 22 May 2019
Date Written: May 16, 2019
Non-fundamental demand shocks have significant effects on asset prices, but observing these shocks is challenging. We show theoretically and empirically that flows into exchange traded funds (ETFs) provide signals of non-fundamental demand shocks. A portfolio which is short high flow ETFs and long low flow ETFs earns excess returns of 1% to 4% per month, consistent with non-fundamental demand distorting asset prices away from fundamental values. Moreover, non-fundamental demand imposes non-trivial costs on ETF investors, leading to underperformance. Our findings show ETFs provide a novel laboratory for studying non-fundamental demand shocks from a broad cross-section of investors.
Keywords: Exchange Traded Funds (ETFs), Investor Flows, Non-Fundamental Demand, Return Predictability
JEL Classification: G12, G14
Suggested Citation: Suggested Citation