ETFs, illiquid assets, and fire sales

John J Shim and Karamfil Todorov

No 975, BIS Working Papers from Bank for International Settlements

Abstract: We document several novel facts about exchange-traded funds (ETFs) holding corporate bonds. First, the portfolio of bonds that are exchanged for new or existing ETF shares (called creation or redemption baskets) often represents a small fraction of ETF holdings – a fact that we call "fractional baskets." Second, creation and redemption baskets exhibit high turnover. Third, creation (redemption) baskets tend to have longer (shorter) durations and smaller (larger) bid-ask spreads relative to holdings. Lastly, ETFs with fractional baskets exhibit persistent premiums and discounts, which is related to the slow adjustment of NAV returns to ETF returns. We develop a simple model to show that an ETF's authorized participants (APs) can act as a buffer between the ETF market and the underlying illiquid assets, and help mitigate fire sales. Our findings suggest that ETFs may be more effective in managing illiquid assets than mutual funds.

Keywords: bonds; ETFs; fire sales; liquidity (search for similar items in EconPapers)
JEL-codes: G01 G11 G12 G23 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2021-11
New Economics Papers: this item is included in nep-cwa
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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