ETFs, Illiquid Assets, and Fire Sales
50 Pages Posted: 16 Jul 2021
Date Written: July 14, 2021
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: Suggested Citation