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Liquidity, style investing and excess comovement of exchange-traded fund returns

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  • Broman, Markus S.

Abstract

This study shows that exchange-traded fund (ETF) misvaluation – based on return differentials between ETFs and their net asset values (NAV) – comove excessively across ETFs. Excess comovements are positive (negative) and significant across ETFs in similar (distant) investment styles. Further tests based on return reversals suggest that misvaluation stems primarily from the ETF, rather than the NAV price. Excess comovements are greater for funds with high commonality in demand shocks and attractive liquidity characteristics. These findings are consistent with the idea that the high liquidity of ETFs attracts a clientele of short-horizon noise traders with correlated demand for investment styles.

Suggested Citation

  • Broman, Markus S., 2016. "Liquidity, style investing and excess comovement of exchange-traded fund returns," Journal of Financial Markets, Elsevier, vol. 30(C), pages 27-53.
    • Handle: RePEc:eee:finmar:v:30:y:2016:i:c:p:27-53
    DOI: 10.1016/j.finmar.2016.05.002
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    Cited by:

    1. Yuan, Ying & Huang, Yizhao & Chen, Haoran, 2021. "Monthly-rebalanced leveraged exchange-traded products: Performance and mandatory rebalancing needs," The North American Journal of Economics and Finance, Elsevier, vol. 57(C).
    2. Yun‐Huan Lee & Tzu‐Hsiang Liao & Hsiu‐Chuan Lee, 2022. "Overnight returns of industry exchange‐traded funds, investor sentiment, and futures market returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(6), pages 1114-1134, June.
    3. Gemayel, Roland & Franus, Tatiana & Bowden, James, 2023. "Price discovery between Bitcoin spot markets and exchange traded products," Economics Letters, Elsevier, vol. 228(C).
    4. Broman, Markus S., 2020. "Local demand shocks, excess comovement and return predictability," Journal of Banking & Finance, Elsevier, vol. 119(C).
    5. Itzhak Ben-David & Francesco A. Franzoni & Rabih Moussawi, 2016. "Exchange Traded Funds (ETFs)," Swiss Finance Institute Research Paper Series 16-64, Swiss Finance Institute.
    6. Baumann, Michael Heinrich & Herz, Bernhard & Baumann, Michaela, 2018. "Exchange-traded Funds, Investment Strategies, and Financial Stability," VfS Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181542, Verein für Socialpolitik / German Economic Association.
    7. Zhou, Liyun & Huang, Jialiang, 2020. "Excess co-movement of agricultural futures prices: Perspective from contagious investor sentiment," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    8. Do, Hung X. & Nguyen, Nhut H. & Nguyen, Quan M.P., 2022. "Multinationals and stock return comovement," Global Finance Journal, Elsevier, vol. 52(C).
    9. Box, Travis & Davis, Ryan & Evans, Richard & Lynch, Andrew, 2021. "Intraday arbitrage between ETFs and their underlying portfolios," Journal of Financial Economics, Elsevier, vol. 141(3), pages 1078-1095.
    10. Xu, Liao & Yin, Xiangkang & Zhao, Jing, 2019. "The sidedness and informativeness of ETF trading and the market efficiency of their underlying indexes," Pacific-Basin Finance Journal, Elsevier, vol. 58(C).

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    More about this item

    Keywords

    ETF; Excess comovement; Correlated demand; Liquidity clientele; Style investing;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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