The present study investigates the issue of excess volatility in index exchange-traded funds (ETFs) in India and analyses how well the costly arbitrage theories apply to this segment of the market. We find that the returns of the average ETF are 110 per cent more volatile as compared to the returns of the underlying portfolio which suggests that public trading introduces an additional layer of volatility in ETFs. Factors that limit arbitrage by making it costly for the arbitrageurs to remove the price-net asset value (NAV) deviations explain about 67 per cent of the variation in excess volatility. The cointegration analysis provides evidence of a long-term equilibrium relationship between price and NAV. Vector error correction model (VECM) results suggest that NAVs lead prices to restore this equilibrium in case of short-run deviations. The analysis also revealed that ETF returns are predictable on the basis of past deviations and may be used to generate returns which are significantly greater than those of a buy-and-hold strategy. Our results are in agreement with the theory of costly arbitrage and are inconsistent with the construct of efficiency in financial markets.

Purpose The objective of the present study is to examine how domestic and foreign exchange traded funds (ETFs) tracking Indian equities affect the return correlations of their underlying constituents. Further, this study investigates how these effects vary between periods of turmoil and calmness in the financial markets.Design/methodology/approach The study is based on quarterly data for stocks comprising the CNX (CRISIL NSE Indices) Nifty 50 Index from 2009Q1 to 2019Q4. The data on holdings of 45 domestic and 196 foreign ETFs in the sample stocks were obtained from Thomson Reuters’ Eikon. The paper employs a panel-regression methodology with stock and time fixed effects and robust standard errors.Findings This study documents that irrespective of the market conditions, foreign ETFs, particularly those from Asia–Pacific and European regions tend to exacerbate co-movement. Conversely, domestic ETFs lower co-movement in stable markets but during periods of turbulence a jump in return correlations is observed.Practical implications The results have important implications for ETF investors as well as market regulators because an increase in co-movement would reduce the diversification benefits of ETFs, thereby nullifying the biggest advantage that ETFs have to offer.Originality/valueThe literature on the economic impact of ETFs is highly skewed with the majority of the studies focusing on developed markets. To the best of the authors’ knowledge, this study is the first one to empirically examine the impact of ETFs on the return co-movement of an emerging market. Furthermore, the study is unique as the authors investigate how the effects of ETFs vary in turbulent and tranquil markets.

The present study investigates how efficiently India-domiciled exchange traded funds (ETFs) replicate the returns of their underlying indices and analyses the factors that determine the tracking performance. We use a three-pronged approach involving Capital Asset Pricing Model (CAPM) regression, cointegration-Vector Error Correction Model methodology and tracking errors (TEs) to assess tracking efficiency. Random-effects panel regression is employed to evaluate how fund-specific factors influence tracking ability. We find that ETFs carry significantly lower exposure towards their indices than what their objective would suggest. Long-run linkages with benchmarks exist for most ETFs, but the price deviations from the indices are fairly persistent. The TEs for the majority of the funds are large and non-trivial. Bid-ask spreads, price-net asset value deviations, fund’s age and, to some extent, its size are the primary factors that influence tracking performance. ETFs in developed markets such as the USA and Europe have been found to exhibit superior benchmarking abilities. The study is expected to assist investors in developing a more efficient ETF portfolio and to help fund providers improve the quality of their offerings.

This paper is an empirical analysis of Index ETFs and Index Funds and aims to evaluate the performance of these two instruments on the basis of the following parameters –Data Envelopment Analysis (DEA), Sharpe Ratio, Active returns and Tracking Error. The examination reveals that ETFs outperformed Index Funds on all parameters during the study period except in case of tracking error. Wilcoxon Signed Rank test has also been conducted to analyse the head-to-head performance of ETFs and Index funds, here also the ETFs produce significantly superior returns. Qualitative differences between these two classes of instrument reveal that Index funds are more suited to small retail investors while ETFs are found to be better for institutional and large investors.

PurposeThe purpose of this study is to ascertain how foreign and domestic Exchange Traded Funds (ETFs) investing in Indian equities affect their return volatility and pricing efficiency. Further, we investigate how the difference in market timings affect the impact of ETFs on their constituents. Lastly, we examine how these effects vary during tranquil and turmoil periods in the ETF markets.Design/methodology/approachThe study is based on quarterly data for stocks comprising the CNX Nifty 50 Index from 2009Q1 to 2019Q3. The data on holdings of 45 domestic and 196 foreign ETFs in the sample stocks were obtained from Thomson Reuters' Eikon. The paper employs a panel-regression methodology with stock and time fixed effects and robust standard errors.FindingsForeign ETFs from North America and the Asia Pacific largely have an adverse impact on stocks' return volatility. In times of turmoil, stocks with higher coverage of European, North American and Domestic funds are susceptible to volatility shocks emanating from these regions. European and Asia Pacific ETFs are associated with improved price discovery while North American funds impound a mean-reverting component in stock prices. However, in turbulent markets, both positive and negative impacts of ETFs on pricing efficiency coexist.Originality/valueTo the best of the authors' knowledge, this is the first study that examines the impact of domestic as well as foreign ETFs on the equities of an emerging market. Furthermore, the study is unique as we investigate how the effects of ETFs vary in turbulent and tranquil markets. Moreover, the paper examines the role of asynchronous market timings in determining the ETF impact. The paper adds to the growing literature on the unintended consequences of index-linked products.