Response of ETF flows and long-run returns to investor sentiment

Padma Kadiyala ()
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Padma Kadiyala: Pace University

Financial Markets and Portfolio Management, 2022, vol. 36, issue 4, No 4, 489-531

Abstract: Abstract ETFs combine features of open-end and closed-end funds. In this paper, we investigate how the unique characteristics affect ETFs’ response to investor sentiment. We employ a novel identification strategy to distinguish between the response of liquidity traders, short-term arbitrageurs and long-term arbitrageurs. We find that liquidity traders respond positively to sentiment, which results in a subsequent cumulative 12-month return of −8%. Long-term arbitrageurs who go long the ETF, and short the underlying asset benefit from this return reversal. Finally, short-term arbitrageurs respond negatively to the Baker and Wurgler (2006) sentiment measure. Their actions are profitable in the long-run as ETFs that experience fewer redemptions from short-term arbitrageurs experience weaker returns reversals.

Keywords: Fund flows; Investor sentiment; Market efficiency; Mental accounting bias; ETFs; Behavioral finance (search for similar items in EconPapers)
JEL-codes: G10 G11 G12 G14 G23 G41 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:kap:fmktpm:v:36:y:2022:i:4:d:10.1007_s11408-022-00410-1

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DOI: 10.1007/s11408-022-00410-1

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