Exchange-Traded Funds and Transparency in Over-the-Counter Markets

Abstract

This paper explores a new channel through which exchange-traded funds (ETFs) can affect underlying asset prices. In over-the-counter markets, daily disclosure of ETF portfolio holdings increases price transparency and thereby retail investors' bargaining power. I show that ETF-held municipal bonds have significantly lower dealer markups than observationally similar non-ETF-held bonds. This effect cannot be explained by bond selection or ETFs' own trading activity. Rather, ETFs' disclosure of end-of-day bond pricing is associated with lower retail markups by 5-9 basis points. 

Keywords: market transparency, information asymmetry, dealer markups, municipal bonds, over-the-counter markets, exchange-traded funds

JEL Classification: G12, G14, G23