Is there a dark side to exchange traded funds? An information perspective
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We examine whether an increase in ETF ownership is accompanied by a decline in pricing efficiency for the underlying component securities. Our tests show an increase in ETF ownership is associated with (1) higher trading costs (bid-ask spreads and market liquidity), (2) an increase in “stock return synchronicity,” (3) a decline in “future earnings response coefficients,” and (4) a decline in the number of analysts covering the firm. Collectively, our findings support the view that increased ETF ownership can lead to higher trading costs and lower benefits from information acquisition. This combination results in less informative security prices for the underlying firms.
KeywordsExchange traded funds (ETFs) Informed and unformed traders Trading costs Informational efficiency Pricing efficiency
JEL classificationsG11 G14 M41
We gratefully acknowledge research assistance from Woo Young Park and Padmasini Venkatachari. We thank Inessa Liskovich and Harrison Hong for kindly providing us with their data on Russell 2000 reconstitutions. We are grateful for helpful suggestions and comments from Russell Lundholm (Editor), Ira Yeung (Discussant), an anonymous referee, Will Cong, Larry Glosten, Ananth Madhavan, Ed Watts, Frank Zhang as well as seminar participants at Emory University, Interdisciplinary Center (IDC) Herzliya, Tel Aviv University, UCLA, the University of Iowa, Duke University, and Harvard University (IMO Conference 2016).
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