Exchange-Traded Funds (ETFs) Increase Stock Volatility

The share of market cap ownership by ETFs in the S&P 500 universe rose from 0.1 percent in 2000 to 7.1 percent in 2015—the amount of assets under management by ETFs is currently more than twice that managed by index mutual funds.

ETFs are traded in the secondary market by retail and institutional investors. Arbitrage opportunities may arise when the price of ETF shares, determined by the supply and demand in the secondary market, diverges from the value of the underlying securities.

Prof. Frarncesco Franzoni

Prof. Frarncesco Franzoni

New research results from Swiss Finance Institute Professor Francesco Franzoni from the Università della Svizzera italiana,  Professor Itzhak Ben-David from the Ohio State University, and Professor Rabih Moussawi from Villanova University show that because arbitrage-driven investors buy and sell ETFs, and simultaneously sell and buy the underlying shares, demand and supply shocks are transferred from the ETFs on to the underlying stocks, and volatility increases.

According to some industry participants, 50 percent of the volume in the S&P 500 tracker is related to arbitrage. Research results show that a one standard deviation increase in ETF ownership leads to an increase in the volatility of S&P 500 stocks of up to 16 percent.

The full version of the June issue of SFI’s Practitioner Roundups is available at http://sfi.ch/system/tdf/Roundup_June18_English.pdf?file=1

 

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