Liquidity and Risk Sharing Benefits from the Introduction of an ETF

Gresse, Carole; De Winne, Rudy; Platten, Isabelle

Gresse, Carole; De Winne, Rudy; Platten, Isabelle (2011-06), Liquidity and Risk Sharing Benefits from the Introduction of an ETF. https://basepub.dauphine.fr/handle/123456789/7686

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Type

Document de travail / Working paper

Date

2011-06

Publisher

Université Paris-Dauphine

Published in

Paris

Abstract (EN)

This article examines how the introduction of an ETF replicating a stock index impacts on the liquidity of the underlying stocks. We find that index stock spreads decline, relative to those of non index stocks, after the introduction of the ETF. Changes in adverse selection do not appear to be a major factor explaining this liquidity improvement. We also fail to relate it to recognition effects. By contrast, we think that it can mainly be explained by a decrease in order processing and order imbalance costs. This is consistent with the arbitrage theory of Fremault (1991) according to which increased cross-market trading provides additional risk sharing capacity.

Subjects / Keywords

transaction costs; liquidity; risk sharing; Exchange-traded fund (ETF); index trading

JEL

G11 - Portfolio Choice; Investment Decisions
G12 - Asset Pricing; Trading Volume; Bond Interest Rates
G14 - Information and Market Efficiency; Event Studies; Insider Trading