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The Pricing of Exchange Traded Funds and the Roles of Primary and Secondary Market Participants

Author

Listed:
  • Gordon J. Alexander

    (John Spooner Chair in Investment Management, 321 19th Avenue South, Carlson School of Management, University of Minnesota, Minneapolis, MN 55455, USA)

  • Mark A. Peterson

    (Gordon and Sharon Teel Professor of Finance, School of Analytics, Finance, and Economics, Southern Illinois University, Carbondale, IL 62901-4626, USA)

Abstract

We study the pricing of exchange traded funds (ETFs) and the associated arbitrage trading of them in the primary and secondary markets. We find a direct relation between primary and secondary market trading that is consistent with market-makers using the primary market to hedge their inventory risk in the secondary market, as well as to facilitate arbitrage. Such trading in both markets keeps ETF prices in line with their net asset value. We conclude that the existence of the primary market enhances secondary market efficiency.

Suggested Citation

  • Gordon J. Alexander & Mark A. Peterson, 2020. "The Pricing of Exchange Traded Funds and the Roles of Primary and Secondary Market Participants," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 10(03), pages 1-27, September.
    • Handle: RePEc:wsi:qjfxxx:v:10:y:2020:i:03:n:s2010139220500135
    DOI: 10.1142/S2010139220500135
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