ETF Trading and the Bifurcation of Liquidity

57 Pages Posted: 14 Jan 2020 Last revised: 15 Jan 2020

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: November 14, 2019

Abstract

Passively managed exchange traded funds (ETFs) are a financial technology that has risen dramatically in the last two decades. Over the same period liquid stocks have become more liquid while illiquid stocks have not experienced a similar improvement. We model investors shifting from trading individual stocks to trading ETFs and generate predictions consistent with the documented bifurcation in liquidity. Using daily ETF creation and redemption activity, we provide empirical evidence that closely matches the model's predictions. The results show that the effects of ETFs on underlying asset markets are driven by their index replication strategy.

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

JEL Classification: G11, G12, G20

Suggested Citation

Brogaard, Jonathan and Heath, Davidson and Huang, Da, ETF Trading and the Bifurcation of Liquidity (November 14, 2019). 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 )

Salt Lake City, UT 84112
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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