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Response of ETF flows and long-run returns to investor sentiment

Author

Listed:
  • Padma Kadiyala

    (Pace University)

Abstract

ETFs combine features of open-end and closed-end funds. In this paper, we investigate how the unique characteristics affect ETFs’ response to investor sentiment. We employ a novel identification strategy to distinguish between the response of liquidity traders, short-term arbitrageurs and long-term arbitrageurs. We find that liquidity traders respond positively to sentiment, which results in a subsequent cumulative 12-month return of −8%. Long-term arbitrageurs who go long the ETF, and short the underlying asset benefit from this return reversal. Finally, short-term arbitrageurs respond negatively to the Baker and Wurgler (2006) sentiment measure. Their actions are profitable in the long-run as ETFs that experience fewer redemptions from short-term arbitrageurs experience weaker returns reversals.

Suggested Citation

  • Padma Kadiyala, 2022. "Response of ETF flows and long-run returns to investor sentiment," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 36(4), pages 489-531, December.
    • Handle: RePEc:kap:fmktpm:v:36:y:2022:i:4:d:10.1007_s11408-022-00410-1
    DOI: 10.1007/s11408-022-00410-1
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    More about this item

    Keywords

    Fund flows; Investor sentiment; Market efficiency; Mental accounting bias; ETFs; Behavioral finance;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • 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
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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