Inefficiencies in the Pricing of Exchange-Traded Funds

Antti Petajisto

Financial Analysts Journal, 2017, vol. 73, issue 1, 24-54

Abstract: The prices of exchange-traded funds (ETFs) can deviate significantly from their net asset values (NAVs), in spite of the arbitrage mechanism that allows authorized participants to create and redeem shares for the underlying portfolios. The deviations, typically within a band of about 200 bps, are larger in funds holding international or illiquid securities. To control for stale pricing of the underlying assets, I introduce a novel approach that uses the cross section of prices on a group of similar ETFs. The average pricing band remains economically significant at about 100 bps, with even larger mispricings in some asset classes. Active trading strategies exploiting such inefficiencies produce substantial abnormal returns before transaction costs, providing further proof of short-term mean reversion in ETF prices.Disclosure:The first draft of this article was written when the author was a finance professor at the NYU Stern School of Business.Editor's Note: Submitted 25 September 2013Accepted 6 October 2016 by Robert Litterman

Date: 2017
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DOI: 10.2469/faj.v73.n1.7

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