Introduction to the Special Issue on Exchange-Traded Funds

Citation

Miu, P. and Charupat, N. (2013), "Introduction to the Special Issue on Exchange-Traded Funds", Managerial Finance, Vol. 39 No. 5. https://doi.org/10.1108/mf.2013.00939eaa.001

Introduction to the Special Issue on Exchange-Traded Funds

Article Type: Guest editorial From: Managerial Finance, Volume 39, Issue 5

About the Guest Editors

Peter Miu, Associate Professor of Finance, DeGroote School of Business, McMaster University. Dr Miu’s research is primarily in the areas of credit risk modeling, exchange-traded funds, bankruptcy prediction, financial institutions, and risk management. His research has been published in various journals such as the Journal of Financial Intermediation, Journal of Banking and Finance, Journal of Empirical Finance, Journal of Financial Research, and Journal of Credit Risk.

Narat Charupat, Associate Professor of Finance, DeGroote School of Business, McMaster University. Dr Charupat’s areas of research interest include financial innovations, life annuities and personal financial management. His research has been published in various journals such as the Journal of Banking and Finance, Journal of Economic Theory, Journal of Financial and Quantitative Analysis, and Journal of Risk and Insurance.

Since their launch in the early 1990s, exchange-traded funds (ETFs) have been one of the fastest-growing investment products available to both institutional and retail investors. Currently, there are about 4,000 ETFs trading globally with close to $1.5 trillion of assets under management. The original idea was to offer investors a low cost alternative for owning diversified portfolios that replicate the returns on major stock market indices with the added benefit of liquidity as the funds are traded on exchanges. The success of the early ETFs led to a new crop of ETF products to satisfy the needs of investors in seeking exposures to different asset classes including commodities, fixed income, foreign currencies, and emerging markets. More recently, leveraged and inverse ETFs have been introduced, which deliver positive or negative multiples of returns on the underlying indices. The trading and management of ETFs have attracted a lot of press coverage and attention from national and international regulators of financial markets and institutions. There have been concerns of the potential systemic risks ETF trading might pose to the financial system. This special volume is therefore timely in addressing different issues in this field of research.

We received a large number of submissions. The manuscripts were blind-reviewed. Based on the comments of the reviewers, a total of five papers were accepted to be included in the special issue. They represent a rich and diverse collection of studies on ETFs covering their effects on the underlying securities, their informational efficiency, the management and trading of leveraged ETFs, the high-frequency analysis on ETF pricing deviation, and a review on recent development of the ETF literature. They have significantly advanced our knowledge, not only on different research issues on ETFs, but also on other related research areas. A better understanding of these issues can enhance the efficiency in the trading and management of ETFs, which will in turn benefit the investors and market participants operating in the ETF and related markets.

Accepted papers

We briefly summarize the contributions of the accepted papers as follows.

In the paper “Recent developments in exchange-traded fund literature: pricing efficiency, tracking ability, and effects on underlying securities”, we review a number of recent studies of three active strands of literature on ETFs. They include the study of the pricing efficiency of ETFs, their tracking ability and performance, and their effects on the securities underlying the benchmark indices. In reviewing each of these research areas, we highlight the main research questions and their key governing factors. We also summarize the main findings of the studies with a particular emphasis on the unresolved issues of the literature. This review can benefit both current and future researchers by providing a broad picture of the existing and emerging research on ETFs, on which they can leverage in devising their research questions.

The paper “Short-sale constraints and securities lending by exchange-traded funds” examines the impact of the introduction of ETFs on the securities underlying the benchmark indices. In particular, by considering the universe of equity ETFs listed on all US exchanges as available from Bloomberg, the authors provide evidence for the easing of the short-sale constraints of the underlying stocks after they are included in ETFs. They find that the short interest increases significantly (by 33 percent) after a stock is first included in an ETF, whereas no increase is detected for the control (matching) stock. Moreover, the alleviation of short-sale constraint is found to be more pronounced for firms that were more short-sale constrained prior to the inclusion in the fund. Given that short-selling ability is one of the prerequisites for attaining informational efficiency, the findings of this study provide a potential avenue through which the introduction of ETFs may enhance the pricing efficiency of the underlying stocks.

In “Speed of convergence to market efficiency in the ETFs market”, the authors study the informational efficiency of ETFs. Specifically, using a sample of 273 ETFs that were traded on Arca during the first six months of 2008, the authors examine the speed at which information is incorporated in the ETF prices. They find that on average it takes about 30 min for new information to be incorporated, which is comparable with that documented in the literature for ordinary shares traded on Arca and NYSE. They also find that the speed of incorporating information is negatively related to trading costs, volatility, and informational effects, while positively related to institutional ownership and trading activity of institutional investors. In a multivariate setting, they find that the speed of convergence to market efficiency is driven by both volume and the probability of informed trading. By advancing our understanding of the underlying determinants of informational efficiency, this study provides the necessary analytics and related evidence for the exchanges, market regulators, and policy-makers to further enhance the market quality of the existing trading mechanism and platforms.

The paper “Leveraged and inverse ETF performance during the financial crisis” examines the tracking ability of a relative new member of the ETF family – leveraged and inverse ETFs. These ETFs are expected to deliver daily returns that are either at constant positive or negative multiples of the underlying benchmark returns. The authors provide a framework for separating the daily compounding effect from the management of the fund in causing the fund’s tracking errors. Focusing on the recent financial crisis, the authors then apply their framework and conduct an empirical analysis using a sample of leveraged ETFs on commodities, domestic, and international equity indices over the time period of 2008-2009. They find that the impact of management factors can outweigh the compounding effect in governing the performance of the funds. They also document a worsening of the pricing efficiency of these funds during the recent financial crisis. The proposed framework will help market participants to have a better understanding of the underlying drivers of the performance of leveraged and inverse ETFs, which represent one of the fastest growing sectors of the ETF markets.

In “High-frequency analysis of exchange traded funds’ pricing deviation”, the author extends the existing studies on ETF pricing deviation (defined as the difference between the ETF price and the underlying index level) by using high-frequency intraday market data. Specifically, he studies three popular equity ETFs, namely the Diamond, the Spider, and the Cubes, that track the Dow Jones Industrial Average, S&P 500 Index and Nasdaq 100 Index, respectively. He finds that pricing deviation has a significant intraday pattern that is related to the trading volume. In contributing to our understanding of the intraday characteristics of pricing deviation, this study can help market participants in their pursuit of profit opportunities involving high-frequency market information.

Acknowledgements

We thank the authors for submitting their papers to the special issue. We are grateful to their understanding and patience throughout the review process. We are in debt to the referees who have kindly agreed to review the manuscripts. Their constructive feedback and comments have significantly enhanced the quality of the papers. We thank Professor Don Johnson (Editor of Managerial Finance) for his support, guidance, and advice. We also thank Samantha Thompson (Managing Editor for Managerial Finance), Sophie Barr, Megan Beech, and Andrea Watson-Lee at Emerald for their assistance in managing the submission, review, and publication processes. Finally, we thank Donghui Chen for his research assistance.

Peter Miu, Narat CharupatGuest Editors