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Do ETFs increase the commonality in liquidity of underlying stocks?

Author

Listed:
  • Agarwal, Vikas
  • Hanouna, Paul
  • Moussawi, Rabih
  • Stahel, Christof W.
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.

Suggested Citation

  • Agarwal, Vikas & Hanouna, Paul & Moussawi, Rabih & Stahel, Christof W., 2021. "Do ETFs increase the commonality in liquidity of underlying stocks?," CFR Working Papers 21-04, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:2104
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    File URL: https://www.econstor.eu/bitstream/10419/232548/1/1752612590.pdf
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    References listed on IDEAS

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    Cited by:

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    2. Ivanov, Ivan T. & Zimmermann, Tom & Heinrich, Nathan W., 2022. "Limits of disclosure regulation in the municipal bond market," CFR Working Papers 22-05, University of Cologne, Centre for Financial Research (CFR).
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    More about this item

    Keywords

    Exchange-Traded Funds (ETFs); Liquidity; Commonality; Arbitrage; Trading Halts; Index Reconstitution;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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