ETFs, Anomalies and Market Efficiency

Abstract

We investigate the effect of ETF ownership on stock market anomalies and market efficiency. We find that low ETF ownership stocks exhibit higher returns, greater Sharpe ratios, and highly significant alphas compared to high ETF ownership stocks. We show that high ETF ownership stocks demonstrate more pronounced information flows than low ETF ownership stocks, reducing their mispricing as they are more informationally efficient. We find similar results when we match the two groups based on size, volume, book-to-market, and momentum. Our results are robust to different matching methods and a wide array of controls in Fama-MacBeth regressions. Using Russell index reconstitution, we find causal evidence that ETF ownership attenuates anomaly returns.

Keywords: ETF arbitrage, Anomalies, Market Efficiency

JEL Classification: G11, G12, G14, G23