Do ETFs Increase the Commonality in Liquidity of Underlying Stocks?
46 Pages Posted: 13 Nov 2017
Date Written: April 26, 2018
We examine the impact of ETF ownership on the commonality in liquidity of underlying stocks, while controlling for the effect of other institutional ownership. Analyses using either aggregate ETF ownership at the stock level or common ETF ownership at the stock pair level indicate that ETF ownership significantly increases commonality. We show that greater arbitrage opportunities and activity are associated with a larger effect of ETF ownership on commonality. We use two quasi natural experiments that exploit ETF trading halts and the reconstitution of Russell indexes, to establish causality. Our results suggest that ETFs reduce investors’ ability to diversify liquidity shocks.
Keywords: Exchange-Traded Funds (ETFs), Liquidity, Commonality, Arbitrage, Trading Halts, Index Reconstitution
JEL Classification: G10, G12, G14, G23
Suggested Citation: Suggested Citation