ETF Arbitrage and International Diversification

83 Pages Posted: 10 Dec 2018 Last revised: 26 Dec 2019

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 ETF market participants when trading country ETFs are mostly driven by shocks to U.S. fundamentals, rather than local risks. Investors react only to negative news about local economies. When U.S. economic uncertainty increases, investors switch to Cash ETFs. We demonstrate that ETF arbitrage mechanism is one of the key channels through which U.S. shocks propagate to local economies leading to increased return correlation with the U.S. market, limiting the benefits from international diversification. We find that countries with stronger ETF price discovery and lower limits to arbitrage have a higher comovement with the U.S. market.

Keywords: ETFs, correlation with the U.S., institutional and retail investors, 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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