Passive Funds Actively Affect Prices: Evidence from the Largest ETF Markets

Abstract

This paper studies exchange-traded funds’ (ETFs) price impact in the most ETF-dominated
asset classes: volatility (VIX) and commodities. I propose a model-independent approach to replicate the VIX futures contract. This allows me to isolate a non-fundamental component in VIX futures prices that is strongly related to the rebalancing of ETFs. To understand the source of that component, I decompose trading demand from ETFs into three parts: leverage rebalancing, calendar rebalancing, and flow rebalancing. Leverage rebalancing has the largest effects. It
amplifies price changes and exposes ETF counterparties negatively to variance.

Keywords: ETF, passive investing, commoditization, VIX, price impact, leverage

JEL Classification: G11, G13, G23