Innovation and Informed Trading: Evidence from Industry ETFs
87 Pages Posted: 4 Mar 2018 Last revised: 10 Aug 2020
Date Written: March 5, 2020
We empirically examine the impact of industry exchange-traded funds (IETFs) on informed trading and market efficiency. We find that IETF short interest spikes simultaneously with hedge fund holdings on the member stock before positive earnings surprises, reflecting long-the-stock/short-the-ETF activity. This pattern is stronger among stocks with high industry risk exposure. A difference-in-difference analysis on the ETF inception event shows that IETFs reduce post-earnings-announcement drift more among stocks with high industry risk exposure, suggesting that IETFs improve market efficiency. We also find that the short interest ratio of IETFs positively predicts IETF returns, consistent with the hedging role of IETFs.
Keywords: ETF, hedge funds, short interest, market efficiency, financial innovation
JEL Classification: G14, G12
Suggested Citation: Suggested Citation