The Impact of ETFs on Asset Markets: Experimental Evidence

Abstract

We examine how exchange traded funds (ETFs) affect asset pricing, volatility and trade volume in a laboratory asset market. We consider markets with or without ETF assets and whether there is zero or negative correlation in asset returns. In the latter case, the diversification benefits of ETFs are most salient. We find that when the returns are negatively correlated, ETFs reduce mispricing and price volatility without decreasing trading volume. When returns are uncorrelated, the ETF has no impact. Thus, our findings suggest that ETFs do not harm, and may in fact improve, price discovery and liquidity in asset markets.

Keywords: ETF, Asset Pricing, Volatility, Volume, Experimental Finance

JEL Classification: G11, G12, G14, C92