Fixed Income ETFs, Bond Liquidity, and Stressed Markets

Abstract

This paper examines the impact of fixed income Exchange-Traded Funds (ETFs) on corporate bond liquidity. By exploiting two distinct quasi-natural experiments of exogenous changes in ETF eligibility, I find that corporate bonds joining (exiting) ETFs experience a decrease (increase) of their transaction costs compared to similar bonds whose ETF ownership remains stable. Moreover, ETFs do not appear to deteriorate the liquidity of their bonds during market stress and ETF arbitrage events. My findings support the theoretical prediction that ETFs complete the market.

Keywords: Exchange-traded funds, Corporate bonds, Liquidity

JEL Classification: G12, G14, G15