Can ETFs Increase Market Fragility? Effect of Information Linkages in ETF Markets

Exchange Traded Funds (ETFs)

“…It is possible that prices more quickly reflect certain pieces of information, and, at the same time, also are more impacted by liquidity shocks. Bhattacharya and O'Hara (2016) propose a model in which ETFs hold assets that are less liquid than the ETF itself.…”

Do ETFs Increase Volatility?

“…Combining theory and empirics, Chinco and Fos () describe the rebalancing cascades that follow from shocks to a nonfundamental stock price and test this theory in the context of ETFs. Bhattacharya and O'Hara () show theoretically that ETFs can increase price fragility due to information linkages. Finally, Malamud () develops a model in which ETFs can affect volatility through the liquidity shock transmission channel as well as through the time‐varying risk premiums that investors require as compensation for taking on exposure to these shocks.…”

Passive Institutional Ownership, R2 Trends, and Price Informativeness

“…Despite this evidence, whether passive investing erodes market efficiency remains an empirical question. For instance, in a theoretical model, Bhattacharya and O'Hara (2016) predict that learning and feedback effects between exchangetraded funds (ETFs) and their underlying assets promote price instability and herding when the underlying asset is hard to trade. Structural factors that reduce information acquisition costs, such as transparency and information production, make detecting mispriced assets easier, but also reduce the size of the reward.…”

“…Consistent with these caveats, several new studies suggest that the rise in passive investing could be eroding price informativeness, and that this erosion could be occurring across multiple markets. For instance, in a theoretical model, Bhattacharya and O'Hara (2016) predict that learning and feedback effects between exchangetraded funds (ETFs) and their underlying assets promote price instability and herding when the underlying asset is hard to trade. Examples of such hard-to-trade assets include high yield bonds, foreign equities, commodities, and other securities traded over-the-counter.…”