Do not blame index funds and ETFs for market volatility. Much like our Asian equity ETF example above, the ETF didn’t increase the volatility of the local market, it just showed you where that market was valued even when it was closed. Click on the tabs below to see more information on Volatility ETFs, including historical performance, dividends, holdings, expense ratios, technical indicators, analysts reports and more. We investigate ETFs impact on volatility in the Western European market where no prior research regarding this issue exists to the best of our knowledge. In Do ETFs Increase Volatility? ETF ownership increases the negative autocorrelation in stock prices. Issue 5, Itzhak Instead, he focuses on the impact of ETFs on liquidity. ETFs also attract short-horizon liquidity traders, however, which contributes to higher price volatility of securities within the ETF basket. Working off-campus? Journal of Finance, Summarized by ETF stock ownership adding a layer of non-fundamental volatility: intraday and daily volatility 3. 1. Click on an ETF ticker or name to go to its detail page, for in-depth news, financial data and graphs. A one standard deviation increase in ETF ownership corresponds to a 0.14% increase in returns. 2018 Analytics help us understand how the site is used, and which pages are the most popular. CFA Institute, Ben-David In his research, now in the working paper stage, Wermers doesn’t tackle the specific question, as other research has done, of whether ETFs increase the volatility of underlying stocks. We thank Pierre Collin-Dufresne; Chris Downing; Vincent Fardeau; Thierry Foucault; Rik Frehen; Denys Glushkov; Jungsuk Han; Johan Hombert; Augustin Landier; David Mann; Rodolfo Martell; Massimo Massa; Albert Menkveld; Robert Nestor; Marco Pagano; Ludovic Phalippou; Anton Tonev; Tugkan Tuzun; Dimitri Vayanos; Scott Williamson; Hongjun Yan; and participants at seminars and conferences at the NBER Summer Institute (Asset Pricing), Toulouse School of Economics, Insead, HEC Paris, the Cambridge Judge Business School, Villanova University, USI Lugano, the 4th Paris Hedge Funds Conference, the 5th Paul Woolley Conference (London School of Economics), the 8th Csef-IGIER Symposium (Capri), the 5th Erasmus Liquidity Conference (Rotterdam), the 1st Luxembourg Asset Pricing Summit, the Center for Financial Policy Conference at the University of Maryland, Jacobs Levy's Quantitative Financial Research Conference at the Wharton School, the Geneva Conference on Liquidity and Arbitrage, the 20th Annual Conference of the Multinational Finance Society, the 7th Rothschild Caesarea Conference, the Swedish House of Finance, the FIRS conference (Toronto), and SAC Capital Advisors for helpful comments and suggestions. All Rights Reserved. The driving channel appears to be arbitrage activity between ETFs and the underlying stocks. CFA. Hence, the evidence supports the hypothesis that ETFs increase noise in … Figure 2 shows why there has been a minor furor of increased volatility at the end of the day. Their final dataset contains 454 distinct equity ETFs, which provide holdings information for 93% of all domestic equity ETFs in the United States between January 2000 and December 2015. Technology and Investment, 2010, 1, 215-220 . Please check your email for instructions on resetting your password. 23 May 2019 the paper is a causal link going from ETF ownership to stock volatility. Itzhak Ben-David is with the Fisher College of Business, The Ohio State University, and NBER. Source: High turnover clientele inherited by the underlying stocks 2. These funds make their money based on the degree to which prices are changing across the market. Ramtohul An earlier version of this paper circulated under the title “ETFs, Arbitrage, and Shock Propagation.” The authors do not have any material disclosure to make. Exchange-traded funds (ETFs) have become popular thanks to such benefits as high liquidity, cost efficiency, and low-cost diversification. During that time, the culprit was thought to be index futures and program trading. No. and you may need to create a new Wiley Online Library account. As a result, stocks with high ETF ownership may require a risk premium. the stocks in the basket, the price of that stock increases, making the ETF price increase and causes indirect demand for the residual stocks. It would be interesting to see whether the findings still apply over a much longer (e.g., 20-year) period. Using identification strategies based on the mechanical variation in ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. This is a list of all US-traded ETFs that are currently included in the Volatility ETFdb.com Category by the ETF Database staff. © 2021 CFA Institute. Rabih Moussawi is with the Villanova School of Business, Villanova University, and Wharton Research Data Services (WRDS) at the Wharton School, the University of Pennsylvania. Exchange-traded funds are a good way to diversify your portfolio. There is indirect evidence Journal of Finance The study covers only a fairly short period, 2000–2015, when the ETF industry was in a growth phase. A volatility ETF is an exchange traded fund (ETF) that tracks share price changes in a specific index of the stock market. In this analysis, a one-standard-deviation increase in ETF ownership is associated with a statistically significant increase in daily volatility that ranges between 9% and 15% of a standard deviation, for S&P 500 stocks. use OLS regressions of daily volatility on ETF ownership at the stock level and at a monthly frequency. 20071), Itzhak Ben-David, Francesco Franzoni, and Rabih Moussawi discover that the stocks that are held within such funds experience substantially higher intraday and daily volatility than stocks without substantial ETF holdings. Contact us if you continue to see this message. We were not able to record your PL credits. The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the nonfundamental volatility of the securities in their baskets. ETFs are typically more liquid than the basket of underlying securities in terms of bid–ask spread, price impact, and turnover and thus appeal to short-term investors. ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility. Rabih we study whether exchange traded funds (etfs)-an asset of increasing importance-impact the volatility of their underlying stocks. Due to their low trading costs, ETFs are potentially a catalyst for short‐horizon liquidity traders. Ben-David Those new uninformed traders would increase the liquidity of stocks. R Please note: The publisher is not responsible for the content or functionality of any supporting information supplied by the authors. Scaremongering about crashes ignores the long-term success of diversified investments. Hence, this evidence suggests our main result of an increase in volatility for ETF-owned securities translates into a symmetric outward stretch of the return distribution. Using identification strategies based on the mechanical variation in ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. We’re using cookies, but you can turn them off in Privacy Settings. We exploit exogenous changes in index membership and find that stocks with higher ETF ownership display significantly higher volatility. Francesco In addition to traditional index arbitrage, ETFs also lend themselves to low-risk profits from creations or redemptions and pairs trading. The authors find a significant and positive relationship between ETF ownership and stock-level volatility. Learn more in our, Ethics for the Investment Management Profession, Code of Ethics and Standards of Professional Conduct, Do ETFs Increase Volatility? Because the increase in stock volatility brought about by ETFs is partly nondiversifiable, it may represent systematic risk for investors with a short-term horizon. Each ETF is placed in a single “best fit” ETFdb.com Category; if you want to browse ETFs with more flexible selection criteria, visit our screener.To see more information of the Volatility ETFs, click on one of the tabs above. I Active ETFs that are below 1% of the assets under management in the sector are also omitted. Due to their low trading costs, exchange-traded funds (ETFs) are a potential catalyst for short-horizon liquidity traders. They then provide evidence that demand shocks in the ETF market imply a mean-reverting component in asset prices, which suggests that the increase in stock return volatility is unlikely to be attributable to an improvement in price discovery brought about by ETFs. Franzoni Stocks with high ETF ownership generate a significant risk premium. Do ETFs "cause" volatility in the stock market? Volume 49 Franzoni acknowledges support from the Swiss Finance Institute. The authors show that portfolios of stocks with high ETF ownership display positive alphas relative to a variety of asset pricing models. December, We’re using cookies, but you can turn them off in Privacy Settings. Expense Ratio: 0.20%, or $20 annually per $10,000 invested. ETFs also attract short-horizon liquidity traders, however, which contributes to higher price volatility of securities within the ETF basket. Franzoni The authors also find that stocks with high ETF ownership tend to display higher volatility than similar securities. Due to their low trading costs, exchange‐traded funds (ETFs) are a potential catalyst for short‐horizon liquidity traders. ETFs also attract short-horizon liquidity traders, however, which contributes to higher price volatility of securities within the ETF basket. Otherwise, you are agreeing to our use of cookies. Do ETFs increase volatility of underlying securities by amplifying their exposure to liquidity shocks through arbitrage? Due to their low trading costs, exchange-traded funds (ETFs) are a potential catalyst for short-horizon liquidity traders. ETF ownership increases the negative autocorrelation in stock prices. Don't Use VIX ETFs to Bet On Volatility Long-term investors shouldn't worry about short-term volatility, which is what VIX ETFs are intended to protect against. Allow analytics tracking. The Cboe Volatility Index (VIX) is based on options of the S&P 500 index. Moussawi Otherwise, you are agreeing to our use of cookies. Available via license: CC BY 4.0. The increase in volatility appears to introduce undiversifiable risk in prices because stocks with high ETF ownership earn a significant risk premium of up to 56 basis points monthly. If you do not receive an email within 10 minutes, your email address may not be registered, Content may be subject to copyright. The authors show that ETFs attract investors with high turnover. We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility. The authors also demonstrate that the intensity of arbitrage activity between ETFs and their baskets magnifies the effect of ETFs on volatility. Ellen Chang Jan. 28, 2019 There’s a certain amount of predictability that low-volatility ETFs … Functional cookies, which are necessary for basic site functionality like keeping you logged in, are always enabled. Downloadable! The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the nonfundamental volatility of … Francesco Franzoni is with Università della Svizzera italiana (USI) Lugano and the Swiss Finance Institute. Learn about our remote access options. The increase in stock volatility brought about by ETFs is partly non-diversifiable and therefore represents, especially for investors with a short trading horizon, a form of systemic risk. Vol. They consider only plain-vanilla products that engage in physical replication. During that time, the culprit was thought to be index futures and program trading. Introduction “Whenever high market volatility occurs, the tendency these accusations and whether the increase in volatility and end of the day price momentum is indeed linked to leveraged ETFs and their rebalancing trades. The 2008 financial crisis has produced volatility levels not seen since the 1987 stock market crash more than 20 years ago. Portfolio managers, short-term traders, and investors interested in investing in ETFs will find the conclusions of this research useful. For the S&P 500, the relationship appears to be a spurious coincidence. We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility. The authors subsequently use the Thomson Reuters Mutual Fund Ownership database as their source of ETF holdings data for the sample. Using identification strategies based on the mechanical variation in ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the nonfundamental volatility of the securities in their baskets. ETFs may increase the nonfundamental volatility of the securities in their baskets. At least part of this volatility effect can be traced to the impact of ETF arbitrage on the mean-reverting component of stock prices. Ben-David acknowledges support from the Neil Klatskin Chair in Finance and Real Estate and from the Dice Center at the Fisher College of Business. It's certainly true that … Imrith F Learn more in our Privacy Policy. We exploit exogenous changes in index membership and find … Leveraged and inverse-leveraged ETFs that use derivatives to deliver the performance of the index are not included in the analysis. Do Leveraged ETFs Increase Volatility.pdf. There are several volatility exchange-traded funds to choose from, including inverse volatility ETFs. Due to their low trading costs, ETFs are potentially a catalyst for short-horizon liquidity traders. The liquidity shocks can propagate to the underlying securities through the arbitrage channel, and ETFs may increase the non-fundamental volatility of the … Furthermore, ETFs made up only 7.05% of the S&P 500 Index market capitalization in 2015, which seems too small for them to have a major impact on price volatility. The authors use data from CRSP, Compustat, Bloomberg, and OptionMetrics to identify ETFs traded on the major US exchanges and extract returns and prices. At the end of the day, a stock is worth what it’s worth and a bond is worth what it’s worth. Keywords: Leveraged ETFs, Volatility, Momentum 1. Any queries (other than missing content) should be directed to the corresponding author for the article. It would thus appear that the volatility brings about a new source of systematic risk. 73 This time, leveraged ETFs and their rebalancing trades have been singled out by some to explain both the spike in volatility and the appearance of large price swings at the end … Read the Privacy Policy to learn how this information is used. using identification strategies based on the mechanical variation in etf ownership, we present evidence that stocks owned by etfs exhibit significantly higher intraday and daily volatility. The relationship between ETF ownership and volatility furthermore seems to increase with the availability of arbitrage capital. This evolution in the ETF market may result in negative effects on the price stability of financial instruments, as recently observed with the collapse of the popular ETF “XIV” which led to an increase in volatility in the stock market. They focus on ETFs that are listed on US exchanges and whose baskets contain US stocks. ETFs have made them more popular and recognized, but their initial introduction and growth did not lead to any perceptible increase in volatility. The 2008 financial crisis has produced volatility levels not seen since the 1987 stock market crash more than 20 years ago. negative, the relationship between ETF ownership and daily skewness, estimated non-parametrically as in Ghysels, Plazzi, and Valkanov (2016), is not significant. It seems to emanate from a transmission of nonfundamental demand shocks from the ETF market to the prices of the underlying stocks via arbitrage. A long–short portfolio of the top minus the bottom quintiles of stocks by ETF ownership is seen to generate a return premium of up to 0.50% monthly. 6 We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility. Do ETFs Increase Volatility? Exchange-traded funds (ETFs) have become popular thanks to such benefits as high liquidity, cost efficiency, and low-cost diversification. (Digest summary). Use the link below to share a full-text version of this article with your friends and colleagues. The full text of this article hosted at iucr.org is unavailable due to technical difficulties. We are especially grateful to Andrew Ellul, Marco Di Maggio, Robin Greenwood (AFA discussant), and Martin Oehmke (NBER discussant). Enter your email address below and we will send you your username, If the address matches an existing account you will receive an email with instructions to retrieve your username, I have read and accept the Wiley Online Library Terms and Conditions of Use. Please try again. This time, leveraged ETFs and their rebalancing trades have been singled out by some to explain both the spike in volatility and the appearance of large price swings at the end … The authors also note that ETFs add noise to stock prices after using variance ratios. The specifics are different based on individual funds, as various volatility ETFs offer exposure to volatility in varied ways. Stocks with high ETF ownership generate a significant risk premium. These alphas could be as high as 0.50% a month. While there are a number of ways to do this, we have highlighted five volatility-hedged ETFs that could prove beneficial amid market uncertainty. Privacy Settings, CFA Institute Journal Review Manage your Professional Learning credits, Published by We estimate that an increase of one standard deviation in ETF ownership is associated with an increase of 16% in daily stock volatility. The short answer is no. (NBER Working Paper No. Exchange-traded funds (ETFs) have become popular thanks to such benefits as high liquidity, cost efficiency, and low-cost diversification. Using identification strategies based on the mechanical variation in ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. Learn more. Moussawi Gregory Davis Add to myFT.
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