Arbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds

45 Pages Posted: 9 Nov 2018 Last revised: 14 Dec 2018

See all articles by David E Rappoport W

David E Rappoport W

Board of Governors of the Federal Reserve System

Tugkan Tuzun

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: November 2, 2018

Abstract

Market liquidity is expected to facilitate arbitrage, which in turn should affect the liquidity of the assets traded by arbitrageurs. We study this relationship using a unique dataset of equity and bond ETFs compiled from big trade-level data. We find that liquidity is an important determinant of the efficacy of the ETF arbitrage. For less liquid bond ETFs, Granger-causality tests and impulse responses suggest that this relationship is stronger and more persistent, and liquidity spillovers are observed from portfolio constituents to ETF shares. Our results inform the design of synthetic securities, especially when derived from less liquid instruments.

Keywords: Exchange traded funds, ETF, market liquidity, law of one-price, arbitrage, ETF premium

JEL Classification: G12, G14

Suggested Citation

Rappoport Wurgaft, David Elias and Tuzun, Tugkan, Arbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds (November 2, 2018). Available at SSRN: https://ssrn.com/abstract=3281384 or http://dx.doi.org/10.2139/ssrn.3281384

David Elias Rappoport Wurgaft (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Tugkan Tuzun

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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