The Two Sides of the Corporate Bond ETF Liquidity Transformation

44 Pages Posted: 27 Aug 2021 Last revised: 15 Nov 2022

See all articles by Caitlin D. Dannhauser

Caitlin D. Dannhauser

Villanova University - Department of Finance

Egle Karmaziene

VU University Amsterdam; Swedish House of Finance

Date Written: February 2, 2022

Abstract

Most ETF trading occurs in secondary markets. Comparing two bonds from the same issuer, greater exposure to ETF exchange trading increases the comovement of bond returns by lowering idiosyncratic risk. Constituency in liquid ETFs mitigates the increased idiosyncratic risk from higher ETF ownership in low systematic noise periods. The impact of liquid ETFs is attributed to their use by insurance companies to address liquidity needs and to faster incorporation of market‐wide news. In periods of heightened systematic noise, greater ETF secondary market exposure increases idiosyncratic and systematic risk. There is no evidence ETFs negatively affect price discovery around issuer‐level downgrades.

Keywords: ETF, corporate bonds, comovement, secondary trading, risk

JEL Classification: G12, G14, D47

Suggested Citation

Dannhauser, Caitlin D. and Karmaziene, Egle, The Two Sides of the Corporate Bond ETF Liquidity Transformation (February 2, 2022). Swedish House of Finance Research Paper No. 22-01, Available at SSRN: https://ssrn.com/abstract=3909932 or http://dx.doi.org/10.2139/ssrn.3909932

Caitlin D. Dannhauser

Villanova University - Department of Finance ( email )

United States
610-519-4348 (Phone)

Egle Karmaziene (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Swedish House of Finance ( email )

Drottninggatan 98
Stockholm, 111 60
Sweden

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