Finance and Economics Discussion Series (FEDS)
November 2020
Arbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds
David E. Rappoport W. and Tugkan Tuzun
Abstract:
Market liquidity is expected to facilitate arbitrage, which in turn should affect the liquidity of the assets traded by arbitrageurs. We study this relationship using a unique dataset of equity and bond ETFs compiled from big trade-level data. We find that liquidity is an important determinant of the efficacy of the ETF arbitrage. For less liquid bond ETFs, Granger-causality tests and impulse responses suggest that this relationship is stronger and more persistent, and liquidity spillovers are observed from portfolio constituents to ETF shares. Our results inform the design of synthetic securities, especially when derived from less liquid instruments.
Accessible materials (.zip)
Keywords: Exchange traded funds, ETF, market liquidity, law of one-price, arbitrage, ETF premium.
DOI: https://doi.org/10.17016/FEDS.2020.097
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.