The Value of ETF Liquidity
European Finance Association 2020 Helsinki
74 Pages Posted: 6 Apr 2020 Last revised: 25 May 2023
Date Written: May 25, 2023
We analyze how ETFs compete. Drawing on a new model and empirical analysis, we show that ETF secondary market liquidity plays a key role in determining fees. More liquid ETFs for a given index charge higher fees and attract short-horizon investors who are more sensitive to liquidity than to fees. Higher turnover from these investors sustains the ETF's high liquidity, allowing the ETF to extract a rent through its fee, and creating a first-mover advantage. Liquidity segmentation through clientele effects generates welfare losses. Our findings resolve the apparent paradox that higher-fee ETFs can not only survive, but flourish in equilibrium.
Keywords: ETFs, liquidity, competition, trading volume
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation