Direct and Indirect Effects of Index ETFs on Spot‐Futures Pricing and Liquidity: Evidence from the CAC 40 Index

Abstract

International audienceThis paper investigates how the introduction of an index security directly or indirectly impacts the underlying-index spot-futures pricing. Using intraday data for financial instruments related to the CAC 40 index, we do not find that the spot-futures price efficiency improvement observed after ETF introduction is explained either by the direct effect of ETF shares being used in arbitrage trades or by the indirect effect of ETF trading improving the liquidity of index stocks in the short run. Some of our findings suggest that the efficiency improvement could rather result from a structural change in the way index traders distribute across index markets, with the ETF market absorbing the liquidity demand from some hedgers or passive index traders

The impact of multilateral trading facilities on price discovery: Further evidence from the European markets

“…The effect of ETFs on arbitrage activities in the spot and futures markets is referred to as the direct effect of ETFs, while the effect of ETFs on the respective underlying stocks' liquidity is described as the indirect effect of ETFs. While in the short term, neither direct nor indirect effect of ETFs on the price efficiency of their component stocks could be observed based on the data used in their study; however, Deville et al (2014) suggest that in the long term, the price efficiency improves, especially through the indirect effect of ETFs. 10 They suggested that the ETFs are more appealing to hedgers and liquidity traders who focus on long-term positions, but they may appear unattractive to arbitrageurs in relation to index futures.…”

“…However, Deville et al (2014) examined the direct and indirect effect of ETFs on their underlying stocks' price efficiency. The effect of ETFs on arbitrage activities in the spot and futures markets is referred to as the direct effect of ETFs, while the effect of ETFs on the respective underlying stocks' liquidity is described as the indirect effect of ETFs.…”

“…We suspect that the data problem may be common. Further, these studies only cover post-2013 literature that involve ETFs, including the most recent ones by Frommherz (2017) and Deville et al (2014), which only cover few years/months of data between 2007-2011.…”

“…This is because either can be characterized by factors such as short-and long-term investments as well as fully-funded and leveraged investments. However, Deville et al (2014) asserted that ETFs attract long-term position hedgers and liquidity traders, and hence, ETFs proliferation may result in the redistribution of index traders across the index markets, which, in turn, can enhance the price efficiency.…”

“…This is because either can be characterized by factors such as short-and long-term investments as well as fully-funded and leveraged investments. However, Deville et al (2014) asserted that ETFs attract long-term position hedgers and liquidity traders, and hence, ETFs proliferation may result in the redistribution of index traders across the index markets, which, in turn, can enhance the price efficiency.After the extensive investigation of the literature, we are urged to further study the role of ETFs in price discovery.This issue is particularly significant and urgent as the recent proliferation of ETFs may lead to changes in the existing price discovery structure. To accomplish the above-sated purpose, we undertake an extensive study of price discovery for three major European price indices, focusing on whether ETFs have surpassed futures or spot indices to become the leading information transmission vehicle.…”