Mind Thy Neighbor's Portfolio: A Network Approach to Contagion in the ETF Market

72 Pages Posted: 28 Dec 2021 Last revised: 27 Nov 2023

See all articles by Bruce Iwadate

Bruce Iwadate

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Date Written: May 1, 2023

Abstract

The exchange-traded fund (ETF) market has become the most important recent development of financial markets. I show that the network of the ETF market — the linkages between ETFs based on portfolio weights — catalyzes the propagation of price dislocations, the gaps between prices and fundamental values. Arbitrage activity induces price dislocations in connected ETFs creating externalities, followed by responses in returns and subsequent reversals with an effect of 3–7% per year. I reconfirm the effects with the Fed announcement of the Bond ETF purchase in 2020. While the ETF market stabilizes price dislocations, induced returns can incur unexpected fluctuations.

Keywords: Contagion, ETF, network, return predictability, authorized participant, federal reserve, corporate credit facility

JEL Classification: G12, G14, G23

Suggested Citation

Iwadate, Bruce, Mind Thy Neighbor's Portfolio: A Network Approach to Contagion in the ETF Market (May 1, 2023). Available at SSRN: https://ssrn.com/abstract=3535942 or http://dx.doi.org/10.2139/ssrn.3535942

Bruce Iwadate (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

HOME PAGE: http://https://www.biwadate.com/

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