ETF Rebalancing, Hedge Fund Trades, and Capital Market

48 Pages Posted: 13 Jan 2023 Last revised: 29 Jan 2023

See all articles by George Jiaguo Wang

George Jiaguo Wang

Lancaster University Management School; New York University - Stern School of Business

Chelsea Yaqiong Yao

Lancaster University - Lancaster University Management School; New York University (NYU) - Leonard N. Stern School of Business

Adina Yelekenova

Lancaster University Management School

Date Written: January 1, 2023

Abstract

We study the interaction between ETF rebalancing and hedge fund “front-running” trades and its implications for the capital market. First, we document that ETF rebalancing has a strong negative relation with future stock returns. Second, we observe that hedge funds gradually increase (decrease) their net arbitrage positions before ETF rebalancing. Strikingly, the “front-running” stocks bought by hedge funds significantly outperform stocks not subject to hedge funds front-running by 0.86% (with a t-statistic of 3.86) before the month of ETF rebalancing. Our findings raise the question of the potential cost of ETFs rebalancing due to their embedded transparency and predictability, which creates anticipatory arbitrage trading by hedge funds.

Keywords: ETF Rebalancing, Hedge Funds, Arbitrage Trades, Stock Returns

JEL Classification: G10, G12, G14, G23

Suggested Citation

Wang, George Jiaguo and Yao, Yaqiong and Yelekenova, Adina, ETF Rebalancing, Hedge Fund Trades, and Capital Market (January 1, 2023). Available at SSRN: https://ssrn.com/abstract=4324054 or http://dx.doi.org/10.2139/ssrn.4324054

George Jiaguo Wang (Contact Author)

Lancaster University Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, Lancashire LA1 4YX
United Kingdom
+44 1524 592 577 (Phone)

HOME PAGE: http://www.lancaster.ac.uk/lums/people/george-wang

New York University - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

Yaqiong Yao

Lancaster University - Lancaster University Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, LA1 4YX
United Kingdom

HOME PAGE: http://www.chelseayao.com

New York University (NYU) - Leonard N. Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY NY 10012
United States

Adina Yelekenova

Lancaster University Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

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