ETFs, Arbitrage, and Contagion
AbstractRecent literature suggests that trading by institutional investors may affect the first and second moments of returns. Elaborating on this intuition, we conjecture that arbitrageurs can propagate liquidity shocks between related markets. The paper provides evidence in this direction by studying Exchange Traded Funds (ETFs), an asset class that has gained paramount importance in recent years. We report that arbitrage activity occurs between ETFs and the underlying assets. Then, we show that ETFs increase the volatility of the underlying assets, and that the prices of the underlying assets are affected by shocks to ETFs. Finally, we present findings consistent with the idea that ETFs served as a conduit for shock propagation between the futures market and the equity market during the Flash Crash on May 6, 2010. Overall, our results suggest that arbitrage activity may induce contagion.
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Bibliographic InfoPaper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2011-20.
Date of creation: Dec 2011
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-01-03 (All new papers)
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