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Exchange-traded funds, liquidity and volatility

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  • Timothy Krause
  • Sina Ehsani
  • Donald Lien

Abstract

Given the exponential growth in exchange-traded fund (ETF) trading, ETFs have become a significant factor in the volatility generating process of their largest component stocks. A simple model of trading is developed for securities that are included in ETFs, and empirical support is provided for the model hypotheses. Volatility spillovers from ETFs to their largest component stocks are economically significant. These spillovers are increasing in liquidity, the proportion of each stock held by the fund, deviations from net asset value, ETF flow of funds and ETF market capitalization. The results are consistent with a positive volume-volatility relation and trading-based explanations of volatility, and are generally stronger for smaller stocks.

Suggested Citation

  • Timothy Krause & Sina Ehsani & Donald Lien, 2014. "Exchange-traded funds, liquidity and volatility," Applied Financial Economics, Taylor & Francis Journals, vol. 24(24), pages 1617-1630, December.
    • Handle: RePEc:taf:apfiec:v:24:y:2014:i:24:p:1617-1630
    DOI: 10.1080/09603107.2014.941530
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    References listed on IDEAS

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    1. Francis X. Diebold & Kamil Yilmaz, 2009. "Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets," Economic Journal, Royal Economic Society, vol. 119(534), pages 158-171, January.
    2. Itzhak Ben‐David & Francesco Franzoni & Rabih Moussawi, 2018. "Do ETFs Increase Volatility?," Journal of Finance, American Finance Association, vol. 73(6), pages 2471-2535, December.
    3. Christopher P. Clifford & Jon A. Fulkerson & Bradford D. Jordan, 2014. "What Drives ETF Flows?," The Financial Review, Eastern Finance Association, vol. 49(3), pages 619-642, August.
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