ETF Arbitrage and International Diversification

63 Pages Posted: 10 Dec 2018 Last revised: 5 Jan 2021

See all articles by Ilias Filippou

Ilias Filippou

Washington University in St. Louis - John M. Olin Business School

Arie Eskenazi Gozluklu

University of Warwick

Hari Rozental

University of Warwick, Warwick Business School, Students

Date Written: October 17, 2019

Abstract

We show that investment decisions of country ETF market participants measured by ETF market order imbalances are driven by global shocks, rather than local risks. We demonstrate that the ETF arbitrage mechanism is one of the key channels through which global shocks propagate to local economies leading to increased return correlation with the U.S. market, limiting the benefits from international diversification. Staggered introduction of country ETFs increases the return correlations between underlying foreign and U.S. market indices. We find that countries with stronger ETF price discovery and lower limits to arbitrage have a higher comovement with the U.S. market lending further support for the proposed arbitrage mechanism.

Keywords: ETFs, equity market correlation, limits to arbitrage, VIX.

JEL Classification: G11, G15.

Suggested Citation

Filippou, Ilias and Gozluklu, Arie Eskenazi and Rozental, Hari, ETF Arbitrage and International Diversification (October 17, 2019). WBS Finance Group Research Paper No. 260, Available at SSRN: https://ssrn.com/abstract=3287417 or http://dx.doi.org/10.2139/ssrn.3287417

Ilias Filippou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Arie Eskenazi Gozluklu

University of Warwick ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

HOME PAGE: http://www.arieskenazi.com

Hari Rozental

University of Warwick, Warwick Business School, Students ( email )

West Midlands, CV4 7AL
United Kingdom

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