Do ETFs increase the commonality in liquidity of underlying stocks?

Vikas Agarwal, Paul Hanouna, Rabih Moussawi and Christof W. Stahel

No 21-04, CFR Working Papers from University of Cologne, Centre for Financial Research (CFR)

Abstract: We examine the impact of ETF ownership on the commonality in liquidity of underlying stocks, while controlling for other institutional ownership. Analyses using aggregate stock-level ETF ownership and common ETF ownership at the stock-pair level indicate that ETF ownership significantly increases commonality. We show that greater arbitrage activities are associated with a larger effect of ETF ownership on commonality. We use quasi-natural experiments that exploit the reconstitution of Russell indexes, and ETF trading halts, to establish the causal effect of ETF ownership and the arbitrage mechanism, respectively. Our results suggest that ETFs reduce investors' ability to diversify liquidity risk.

Keywords: Exchange-Traded Funds (ETFs); Liquidity; Commonality; Arbitrage; Trading Halts; Index Reconstitution (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 G23 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-cwa and nep-mst
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfrwps:2104

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