ETFs, Illiquid Assets, and Fire Sales

50 Pages Posted: 16 Jul 2021

See all articles by John J. Shim

John J. Shim

University of Notre Dame - Mendoza College of Business

Karamfil Todorov

London School of Economics & Political Science, Department of Finance; Bank for International Settlements

Date Written: July 14, 2021

Abstract

We document several novel facts about exchange-traded funds (ETFs) holding corporate bonds. First, the portfolio of bonds that are exchanged for new or existing ETF shares (called creation or redemption baskets) often represents a small fraction of ETF holdings – a fact that we call “fractional baskets.” Second, creation and redemption baskets exhibit high turnover. Third, creation (redemption) baskets tend to have longer (shorter) durations and smaller (larger) bid-ask spreads relative to holdings. Lastly, ETFs with fractional baskets exhibit persistent premiums and discounts, which is related to the slow adjustment of NAV returns to ETF returns. We develop a simple model to show that an ETF’s authorized participants (APs) can act as a buffer between the ETF market and the underlying illiquid assets, and help mitigate fire sales. Our findings suggest that ETFs may be more effective in managing illiquid assets than mutual funds.

Keywords: Bonds, ETFs, Fire Sales, Liquidity

JEL Classification: G01, G11, G12, G23

Suggested Citation

Shim, John J. and Todorov, Karamfil, ETFs, Illiquid Assets, and Fire Sales (July 14, 2021). Available at SSRN: https://ssrn.com/abstract=3886881 or http://dx.doi.org/10.2139/ssrn.3886881

John J. Shim (Contact Author)

University of Notre Dame - Mendoza College of Business ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

Karamfil Todorov

London School of Economics & Political Science, Department of Finance ( email )

London
Great Britain

HOME PAGE: http://ktodorov.com

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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