Passive management and the creation/redemption process can help minimize capital gains distributions. Each of these capital markets players contributes to ETFs trading more efficiently throughout the day, which benefits both buyers and sellers. There are also economic benefits for the capital markets participants.
An increase in the short-term rate reduces the liquidity spillover, whereas a rise in the default spread increases the liquidity spillover. Specifically, we find that the liquidity spillover between the ETF and its component stocks is higher when short-sale restrictions lessen. Our paper investigates market-level determinants of the liquidity spillover between the ETF and its underlying portfolio. Liquidity spillover shares similar market-level determinants to liquidity commonality. These findings are consistent with the “wealth effect” theory of financial contagion of Kyle and Xiong (2002), which argues that increased risk aversion in the marketplace intensifies liquidity spillover among asset classes.
ETFs actually operate in a fundamentally different ecosystem to other instruments that trade on stock exchanges, such as individual stocks or closed-end funds. Whereas these securities have a fixed supply of shares in circulation, %KEYWORD_VAR% ETFs are open-ended investment vehicles with the ability to issue or withdraw shares on the secondary market according to investor supply and demand. Second, ETFs have distinct characteristics that stocks do not possess.
- The real-time trading feature of ETFs provides intraday liquidity, allowing investors to execute trades throughout the trading day.
- ETFs are open-ended, meaning units can be created or redeemed based on investor demand.
- The “secondary market” liquidity seen on exchanges is important for ETF investors and traders.
- It is educational in nature and not designed to be a recommendation for any specific investment product, strategy, plan feature or other purposes.
- Liquidity spillover shares similar market-level determinants to liquidity commonality.
- He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
In addition, ETFs are similar to closed-end funds (CEFs) in that they are traded on exchanges.4 Unlike CEFs, the total number of shares can be increased or decreased depending on market demand and supply. In other words, ETFs are designed to combine the creation and redemption process of open-end funds with the continuous trading of the CEFs. These characteristics form the crucial mechanism that enables the facilitation of arbitrage between the ETF and its underlying assets.
