Open AccessArbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds
Author(s) -
David Rappoport,
Tugkan Tuzun
Publication year - 2020
Publication title -
finance and economics discussion series
Language(s) - English
Resource type - Journals
eISSN - 2767-3898
pISSN - 1936-2854
DOI - 10.17016/feds.2020.097
Subject(s) - market liquidity , arbitrage , business , monetary economics , equity (law) , portfolio , index arbitrage , financial economics , bond , financial system , risk arbitrage , economics , finance , capital asset pricing model , arbitrage pricing theory , political science , law
Market liquidity is expected to facilitate arbitrage, which in turn should affect the liquidity of the assets traded by arbitrageurs. We study this relationship using a unique dataset of equity and bond ETFs compiled from big trade-level data. We find that liquidity is an important determinant of the efficacy of the ETF arbitrage. For less liquid bond ETFs, Granger-causality tests and impulse responses suggest that this relationship is stronger and more persistent, and liquidity spillovers are observed from portfolio constituents to ETF shares. Our results inform the design of synthetic securities, especially when derived from less liquid instruments.