Corporate Bond ETFs, Bond Liquidity, and Stressed Markets

Abstract

This paper examines the impact of corporate bond Exchange-Traded Funds (ETFs) on the liquidity of their bonds. I find that corporate bond ETFs decrease the transaction costs of their constituent securities. The use of a quasi-natural experiment, that controls for the identification issues of self-selection and of an index effect, establishes a causal relation between ETF ownership and bond liquidity. Moreover, ETFs do not deteriorate the liquidity of their bonds during ETF arbitrage and market stress events. The ETF trading volume appears to be the transmission mechanism driving the results.

Keywords: Exchange-traded funds, Corporate bonds, Liquidity

JEL Classification: G12, G14, G15