Does the Law of One Price Hold for South African Exchange Traded Funds?

Exchange-traded funds (ETFs) trade at a market-determined price, which should be equal to their Net Asset Value (NAV) based on the law of one price. This study examines whether a long-run equilibrium relationship between the price and NAV exists for four South African-listed ETFs using Johansen’s cointegration. A common stochastic trend is found between the price and NAV for all the funds; however, this relationship only conforms to the law of one price for three of the four funds. Both the price and NAV are found to correct for the disequilibrium in the long-run relationship which is surprising as if the arbitrage process of creating and deleting units associated with ETFs was the predominant driver of the equilibrium relationship as theory suggests, then it would be expected that only the price would adjust to correct for any disequilibrium. The profile persistence analysis confirms that the deviations from the NAV do not persist. The findings of this study thus suggest that the market for ETFs in South Africa is reasonably efficient and hence retail investors are not likely to be exposed to substantial mispricing which could adversely affect their returns from holding ETFs.