Equity ETF Inefficiencies During Market Disruptions: The Role of Liquidity, Short-Selling, and Information Shocks
We document that the magnitude of spreads between equity ETF prices and the value of their corresponding constituent equities widened substantially during the period of market disruption at the onset of the COVID–19 pandemic, with plethora of equity ETF premiums and discounts that are directionally consistent with the smaller premiums and discounts of the period before the market distress. We show that ETF-constituent spreads widen particularly in days of high return volatility, typically indicating a dumping effect wherein ETF prices move in line with the value of the constituent basket but displaying returns of smaller magnitude. We show that relative differences in liquidity and short-selling constraints between the ETF and constituent equities partly explain the dynamics of ETF-constituent spreads, particularly in days of large price movements. Overall, our results shed light on how frictions in equity ETF markets are manifested in periods of high volatility.
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