ETF Design and Asset Markets

61 Pages Posted: 14 Jan 2020 Last revised: 29 Jan 2021

See all articles by Jonathan Brogaard

Jonathan Brogaard

University of Utah - David Eccles School of Business

Davidson Heath

University of Utah - David Eccles School of Business

Da Huang

University of Utah - David Eccles School of Business

Date Written: January 20, 2020

Abstract

This paper theoretically and empirically shows that passive investing has heterogeneous effects on asset markets. We develop a model which predicts that funds optimally underweight illiquid index assets. Instrumenting for trading activity from exchange traded funds (ETFs), we show that ETF trading reduces the market quality of liquid assets but does not impact the market quality of illiquid assets. The effects are stronger for funds that explicitly sample their underlying index, compared to funds that are fully replicating. Thus, the effects of passive investing on asset markets depend on how intermediaries replicate their target index.

Keywords: exchange-traded funds, passive investment, index, replication strategy, market quality

JEL Classification: G11, G12, G20

Suggested Citation

Brogaard, Jonathan and Heath, Davidson and Huang, Da, ETF Design and Asset Markets (January 20, 2020). Available at SSRN: https://ssrn.com/abstract=3510359 or http://dx.doi.org/10.2139/ssrn.3510359

Jonathan Brogaard

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

HOME PAGE: http://www.jonathanbrogaard.com

Davidson Heath (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Da Huang

University of Utah - David Eccles School of Business ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

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