Intraday Arbitrage Between ETFs and their Underlying Portfolios
73 Pages Posted: 30 Jan 2019 Last revised: 15 Feb 2020
Date Written: February 13, 2020
Prior research suggests that ETF arbitrage affects the market quality of underlying securities. We directly test this proposition by examining minute-by-minute returns and order imbalances, but find little evidence that trading in ETFs impacts the underlying. Panel vector autoregression shows ETF returns largely follow the underlying returns. We also find that mispricing events are preceded by underlying price and order imbalance shocks, corrected by ETF quote adjustments unrelated to order imbalance, inconsistent with an arbitrage explanation. Extending our analysis to a daily frequency also reveals little to no relation between ETFs and the market quality of their constituent securities.
Keywords: Exchange traded funds (ETFs), limits to arbitrage, liquidity
JEL Classification: G12, G14
Suggested Citation: Suggested Citation