Intraday Arbitrage Between ETFs and their Underlying Portfolios

73 Pages Posted: 30 Jan 2019

See all articles by Travis Box

Travis Box

University of Mississippi - Department of Finance

Ryan Davis

University of Alabama at Birmingham

Richard B. Evans

University of Virginia - Darden School of Business

Andrew A Lynch

University of Mississippi - Department of Finance

Date Written: January 25, 2019

Abstract

Current research suggests that arbitrage activity in exchange traded funds (ETFs) impacts the market quality of their constituent securities. We examine this proposition directly by identifying intraday arbitrage opportunities between 423 domestic equity ETFs and their underlying portfolios. Ultimately, we find little evidence that mispricing events alter the direction of constituent order flow. Furthermore, we observe that arbitrage opportunities are usually preceded by a price shock and order imbalance in the underlying portfolio. Even though prices for the ETF and constituent securities converge quickly, parity is restored through adjustments in the best bid and offer quotes, not arbitrage trading. Moreover, the direction of order flow following a mispricing event is more consistent with liquidity provider hedging, whereby aggressive price quotes for the ETF might serve to offset liquidity provision in the underlying securities.

Keywords: Exchange traded funds (ETFs), limits to arbitrage, liquidity

JEL Classification: G12, G14

Suggested Citation

Box, Travis and Davis, Ryan and Evans, Richard B. and Lynch, Andrew A, Intraday Arbitrage Between ETFs and their Underlying Portfolios (January 25, 2019). Available at SSRN: https://ssrn.com/abstract=3322400 or http://dx.doi.org/10.2139/ssrn.3322400

Travis Box (Contact Author)

University of Mississippi - Department of Finance ( email )

Oxford, MS 38677
United States

Ryan Davis

University of Alabama at Birmingham ( email )

Birmingham, AL 35294
United States

Richard B. Evans

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4030 (Phone)
434-243-7680 (Fax)

HOME PAGE: http://faculty.darden.virginia.edu/evansr/

Andrew A Lynch

University of Mississippi - Department of Finance ( email )

360 Holman Hall
University, MS 38677
United States

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