Do ETFs Increase the Commonality in Liquidity of Underlying Stocks?

53 Pages Posted: 13 Jul 2017 Last revised: 11 Dec 2018

See all articles by Vikas Agarwal

Vikas Agarwal

Georgia State University; University of Cologne - Centre for Financial Research (CFR)

Paul Hanouna

Villanova University - School of Business

Rabih Moussawi

Villanova University - Department of Finance; University of Pennsylvania - The Wharton School

Christof W. Stahel

Independent

Date Written: November 20, 2018

Abstract

We examine the impact of ETF ownership on the commonality in liquidity of underlying stocks, while controlling for other institutional ownership. Analyses using aggregate stock-level ETF ownership and common ETF ownership at the stock-pair level indicate that ETF ownership significantly increases commonality. We show that greater arbitrage activities are associated with a larger effect of ETF ownership on commonality. We use quasi-natural experiments that exploit the reconstitution of Russell indexes, and ETF trading halts, to establish the causal effect of ETF ownership and the arbitrage mechanism, respectively. Our results suggest that ETFs reduce investors' ability to diversify liquidity risk.

Keywords: Exchange traded funds, commonality in liquidity, authorized participants, arbitrage, institutional ownership, trading halts, index reconstitution, liquidity risk

JEL Classification: G20, G23

Suggested Citation

Agarwal, Vikas and Hanouna, Paul E. and Moussawi, Rabih and Stahel, Christof W., Do ETFs Increase the Commonality in Liquidity of Underlying Stocks? (November 20, 2018). 28th Annual Conference on Financial Economics and Accounting; Fifth Annual Conference on Financial Market Regulation 2018. Available at SSRN: https://ssrn.com/abstract=3001524 or http://dx.doi.org/10.2139/ssrn.3001524

Vikas Agarwal (Contact Author)

Georgia State University ( email )

35 Broad Street,
Suite 1221
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
404-413-7312 (Fax)

HOME PAGE: http://www.gsu.edu/~fncvaa

University of Cologne - Centre for Financial Research (CFR)

Albertus-Magnus Platz
Cologne, 50923
Germany

Paul E. Hanouna

Villanova University - School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States

Rabih Moussawi

Villanova University - Department of Finance ( email )

800 E Lancaster Ave
Bartley Hall, 2051
Villanova, PA 19085
United States

HOME PAGE: http://www.homepage.villanova.edu/rabih.moussawi

University of Pennsylvania - The Wharton School ( email )

United States

Christof W. Stahel

Independent ( email )

No Address Available

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