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Liquidity provision in ETF markets : The basket and beyond

Author

Listed:
  • Anna Calamia

    (Toulouse Business School - Toulouse Business School)

  • Laurent Deville

    (EDHEC - EDHEC Business School - UCL - Université catholique de Lille)

  • Fabrice Riva

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

Abstract

We provide a theory and empirical evidence showing that the liquidity (quoted spread) of an ETF is strongly determined by inventory-risk related variables. We consider a risk averse market maker who optimally chooses to either manage her ETF position through trading, or resort to the ETF creation/redemption mechanism to exchange her residual inventory for the underlying basket. The trade-off between the ETF price concession and the cost of trading the basket is key in explaining liquidity provision in ETFs. Using data on European equity ETFs, we provide supporting evidence that ETF spreads depend on the risks and costs of inventory management. We also find that the ETF liquidity is linked with the basket liquidity only when market conditions make on-exchange inventory management unsuitable.

Suggested Citation

  • Anna Calamia & Laurent Deville & Fabrice Riva, 2019. "Liquidity provision in ETF markets : The basket and beyond," Post-Print hal-02277671, HAL.
    • Handle: RePEc:hal:journl:hal-02277671
    as

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