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The anatomy of bond ETF arbitrage

Author

Listed:
  • Karamfil Todorov

Abstract

Exchange-traded funds (ETFs) allow a wide range of investors to gain exposure to a variety of asset classes. They rely on authorised participants (APs) to perform arbitrage, ie align ETFs' share prices with the value of the underlying asset holdings. For bond ETFs, prominent albeit understudied features of the arbitrage mechanism are systematic differences between the baskets of bonds used to create and redeem ETF shares, and a low overlap between these baskets and actual asset holdings. These features could reflect the illiquid nature of bond trading, ETFs' portfolio management and APs' incentives. The decoupling of baskets from holdings weakens arbitrage forces but allows ETFs to absorb shocks on the bond market.

Suggested Citation

  • Karamfil Todorov, 2021. "The anatomy of bond ETF arbitrage," BIS Quarterly Review, Bank for International Settlements, March.
    • Handle: RePEc:bis:bisqtr:2103d
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    References listed on IDEAS

    as
    1. Srichander Ramaswamy, 2011. "Market structures and systemic risks of exchange-traded funds," BIS Working Papers 343, Bank for International Settlements.
    2. Terrence Hendershott & Ananth Madhavan, 2015. "Click or Call? Auction versus Search in the Over-the-Counter Market," Journal of Finance, American Finance Association, vol. 70(1), pages 419-447, February.
    3. Sirio Aramonte & Fernando Avalos, 2020. "The recent distress in corporate bond markets: cues from ETFs," BIS Bulletins 6, Bank for International Settlements.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Rhodes, Meredith E. & Mason, Joseph R., 2023. "ETF ownership and firm-specific information in corporate bond returns," Journal of Financial Markets, Elsevier, vol. 63(C).
    2. Yuet Chau & Karamfil Todorov & Eyub Yegen, 2025. "ETFs as a disciplinary device," BIS Working Papers 1261, Bank for International Settlements.
    3. Matteo Aquilina & Giulio Cornelli & Nikola Tarashev, 2025. "Commonality under pressure: banks and funds," BIS Quarterly Review, Bank for International Settlements, March.
    4. Simone Letta & Pasquale Mirante, 2023. "Investigating the determinants of corporate bond credit spreads in the euro area," Mercati, infrastrutture, sistemi di pagamento (Markets, Infrastructures, Payment Systems) 36, Bank of Italy, Directorate General for Markets and Payment System.
    5. repec:bdi:wptemi:misp_036_23 is not listed on IDEAS
    6. Chen, Yu-Lun & Xu, Ke & Yang, J. Jimmy, 2025. "Market impact of the bitcoin ETF introduction on bitcoin futures," International Review of Financial Analysis, Elsevier, vol. 97(C).
    7. Raddatz K., Claudio E., 2025. "Authorized participants’ regulatory constraints and limits to ETF arbitrage during market turmoil Evidence from the dash-for-cash episode," Journal of Banking & Finance, Elsevier, vol. 179(C).

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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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