Do ETFs Increase Stock Volatility?
Exchange-traded funds (ETFs) have become increasingly popular. The share of market cap ownership by ETFs in the S&P 500 universe rose from 0.1 percent in 2000 to 7.1 percent in 2015—the amount of assets under management by ETFs is currently more than twice that managed by index mutual funds. ETFs’ increased popularity relative to traditional index funds is largely driven by the increased access they provide to liquidity and diversification. One could, however, wonder whether the ease of trade that makes ETFs’ success leads to unintended consequences for the underlying securities in ETF baskets.
The research results of SFI Professor Francesco Franzoni and fellow researchers show that because arbitrage-driven investors buy and sell ETFs, and simultaneously sell and buy the underlying shares, demand and supply shocks are transferred from the ETFs on to the underlying securities and volatility increases. Giordano Lombardo of Rationis Srl highlights that this effect is more relevant for some investors than others depending on their investment horizon, but is not well known among investors. He thus stresses the importance of investor education concerning ETFs, for retail and professional investors alike.
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