Smart Money Flows Into ETFs and Investor Sentiment

47 Pages Posted: 28 May 2020

See all articles by Padma Kadiyala

Padma Kadiyala

Pace University - Lubin School of Business

Date Written: May 28, 2020

Abstract

ETFs attract a larger proportion of institutional investors than do the underlying markets. The price of an ETF will deviate from the price of the underlying, if institutional investors are less prone to investor sentiment-driven mispricing, than are retail investors. We employ a unique identification strategy to differentiate between the response of liquidity traders, long-term and short-term arbitrageurs to sentiment measures. Liquidity traders respond positively to sentiment, which results in weaker returns in the following 3- to 6-month period. Long-term arbitrageurs who go long the ETF, and short the underlying asset benefit from this mid-term return reversal. Finally, short-term arbitrageurs respond negatively to the Baker and Wurgler (2006) sentiment measure. Their actions are profitable in the long-run as ETFs that experience higher short-term arbitrage activity experience weaker reversals.

Keywords: Fund flows, Investor sentiment, market efficiency, mental accounting bias, ETFs, behavioral finance

JEL Classification: G10, G11, G12, G14, G23, G41

Suggested Citation

Kadiyala, Padma, Smart Money Flows Into ETFs and Investor Sentiment (May 28, 2020). Pace University Research Paper, Available at SSRN: https://ssrn.com/abstract=3612999 or http://dx.doi.org/10.2139/ssrn.3612999

Padma Kadiyala (Contact Author)

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States
914-773-3620 (Phone)

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