ETFs, Illiquid Assets, and Fire Sales

84 Pages Posted: 16 Jul 2021 Last revised: 27 Nov 2023

See all articles by John J. Shim

John J. Shim

University of Notre Dame - Mendoza College of Business

Karamfil Todorov

Bank for International Settlements

Date Written: October 10, 2023

Abstract

Can ETFs trigger fire sales in illiquid assets? We develop and empirically examine a model where an authorized participant (AP) holds bond inventory and connects the ETF to the underlying bond market. For redemptions, the AP acts as a buffer between the two markets, holding redeemed bonds to preserve the mark-to-market value of her inventory and avoid a fire sale. The AP behaves asymmetrically for creation and transmits ETF purchases to the bond market to boost mark-to-market values. The AP’s costs of handling creations/redemptions are paid by liquidity-demanding ETF investors via premiums/discounts. We document new empirical facts motivated by the model, and provide a novel explanation for why ETFs holding more liquid bonds traded at larger discounts than those holding illiquid bonds during the COVID-induced sell-off in March 2020. Our findings show that ETFs have advantages over mutual funds in managing illiquid assets.

Keywords: ETFs, bonds, fire sales, liquidity, COVID

JEL Classification: G01, G11, G12, G23

Suggested Citation

Shim, John J. and Todorov, Karamfil, ETFs, Illiquid Assets, and Fire Sales (October 10, 2023). 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

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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