Trading on ETF mispricings
Abstract
Purpose
Prior literature has shown deviations between ETF prices and their net-asset-value (NAV) to exist. Fulkerson and Jordan (2013, p. 31) question “if there exists a true tradeable strategy” to exploit these inefficiencies. The purpose of this paper is to implement a profitable daily long-short trading strategy based on price/NAV information and explicitly accounting for trading costs.
Design/methodology/approach
For a sample of European sector ETFs, the authors analyze gross and net returns of a long-short trading strategy in the capital asset pricing model and Fama-French three-factor model.
Findings
The authors document positive gross excess return for the long-short trading strategy in all sample periods, but net excess returns to be positive only between 2008 and 2010.
Research limitations/implications
The results document a profitable long-short trading strategy exploiting deviations between ETF prices and NAV and highlight the impact of trading costs in ETF markets. Due to the limited availability of historic trading cost data, the research uses a comparatively small sample size.
Practical implications
The net profitability of long-short trading in ETFs is only found in times of high uncertainty in the stock market.
Originality/value
The inclusion of trading costs enables a detailed comparison between gross and net returns in ETF trading, addressing potential limits to arbitrage.
Keywords
Acknowledgements
The authors thank the editors and the authors’ two anonymous referees for their very helpful comments. Part of this research was conducted while Yvonne Kreis was at Gutenberg University of Mainz. The views expressed in this paper are those of the authors.
Citation
Kreis, Y. and Licht, J.W. (2018), "Trading on ETF mispricings", Managerial Finance, Vol. 44 No. 3, pp. 357-373. https://doi.org/10.1108/MF-03-2017-0087
Publisher
:Emerald Publishing Limited
Copyright © 2018, Emerald Publishing Limited