ETFs, Anomalies and Market Efficiency

Abstract

This paper investigates the role of exchange-traded fund (ETF) ownership in enhancing market efficiency, drawing on a comprehensive set of over 200 return anomalies in the U.S. equity market. Controlling for key confounding factors such as short-selling constraints, arbitrage costs, and information environments, we find that higher ETF ownership is associated with reduced mispricing and lower anomaly-based returns. Using Russell index reconstitution as a natural experiment, we provide additional causal evidence of ETF ownership attenuating anomaly profits. The mitigating effect of ETF ownership on mispricing is primarily driven by active ETFs and is more pronounced for build-up anomalies than for resolution anomalies. Further analyses reveal that ETFs attenuate mispricing by facilitating both ex-ante information acquisition and ex-post information incorporation. Overall, our findings suggest that ETFs contribute to improved market efficiency by reducing mispricing arising from a broad range of anomalies. 

Keywords: ETFs, ETF ownership, Anomalies, Market Efficiency

JEL Classification: G11, G12, G14, G23