Unravelling the return and volatility interdependencies between Indian equity ETFs and benchmark indices

This study investigates the time-varying volatility interconnectedness between Indian equity exchange traded funds (ETFs) and their underlying benchmark indices. Using Diebold and Yilmaz's generalised VAR model and the benchmark bivariate GARCH-BEKK model, it consistently finds bidirectional return and volatility spillovers among most equity ETFs, indicating market efficiency. Notably, sectoral ETFs exhibit higher sensitivity to benchmark index shocks than broad index ETFs. A 200-day rolling window analysis reveals an increased volatility spillover effect between ETFs and their underlying indices during the initial phase of the COVID-19 crisis in India. The key implication is that the equity ETF market is largely efficient. Investors may face difficulties consistently achieving abnormal returns since authorised participants (APs) help correct temporary mispricing through the creation/redemption process. Additionally, some equity ETFs exhibit tracking inefficiency, prompting caution among investors when selecting ETFs, considering volatility as a key factor affecting tracking efficiency.