Academic journal article Financial Services Review

Empirical Analysis of ETF Intraday Trading

Academic journal article Financial Services Review

Empirical Analysis of ETF Intraday Trading

Article excerpt


We investigate the trading of benchmark Exchange traded funds (ETFs), leveraged ETFs, and leveraged inverse ETFs that are matched based on their tracking index or sector. We find that ETF trading is very active and average daily trading volume for the most active ETF is more than $25 billion during the period of March 2007 to December 2009. The daily turnover ratio of leveraged and leveraged inverse ETFs are about four to six times the turnover ratio of the benchmark ETFs on average, and spreads and price volatility of the leveraged and leveraged inverse ETFs are also significantly larger than those of the benchmark ETFs. Trading volume and turnover ratio of all ETFs increased significantly during and after the financial crisis and the active trading is further enhanced when the price movement of benchmark ETFs is large. We also find that small trades dominate trading of all ETFs, and yet they do not play an important role in daily price movements. In addition, we find a U-shaped and an L-shaped intraday pattern for trading volume and return volatility, respectively. These empirical results are important for individual investors, especially those who do not have sophisticated trading experience and lack resources for collecting and processing private information.

J EL classification: G14

Keywords: Exchange traded funds; Leveraged ETFs; Leveraged inverse ETFs; Bear market; Financial crisis; Intraday trade pattern; Basket securities © 2012 Academy of Financial Services. All rights reserved.

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Exchange traded funds (ETFs) have become increasingly popular in recent years because they offer investors the benefits of easy transaction and diversification. According to the National Stock Exchange, ETF trading volume averaged 1.9 billion shares per day in 2009, and assets in United States listed exchanged traded products totaled $791 billion at the end of December 2009, which is a 47% increase from the previous year (Laise, 2010). The monthly industry review of Barclays Global Investors shows that ETFs accounted for 33% of all U.S. stock trading volume through the first three quarters of 2009. l In addition, the number of leveraged and leveraged inverse ETFs, first introduced to the market by Proshares in 2006, increased greatly during the financial crisis because of the embedded leverage features.2 However, limited empirical evidence exists on how ETFs are traded and whether the trading is affected by different market environments. In addition, it is unclear whether the trading pattern of the innovative ETFs differs from that of benchmark ETFs, although theories suggest that leveraged and leveraged inverse ETFs are suitable only for short-term traders because the embedded path-dependent option could lead to value destruction for a buy-and-hold investor (Cheng and Madhavan, 2009; Guedj, Li, and McCann, 2010).

To provide a better understanding of these issues for individual investors, who are generally regarded as uninformed traders (Grossman, 1976; Grossman and Stiglitz, 1980; Patel et al., 1991) and lack sophisticated trading experience in financial products (Walther, 1995; Indro, 2004), we show detailed empirical analyses of ETF intraday trading using high-frequency data. To illustrate the trade patterns of different types of ETFs, we match 22 triplets of ETFs (22 X 3): benchmark ETFs, leveraged ETFs, and leveraged inverse ETFs. ETFs in each triplet track the same index or sector, but they differ in their return generating process. Benchmark ETFs are designed to provide the same amount (1 X) of daily return as the tracking index, leveraged ETFs are designed to double the daily return (2X) of the tracking index, whereas leveraged inverse ETFs bet on the occurrence of a bear market and generate twice the negative daily return (- 2X) of the tracking index. We use these matched ETFs to investigate several empirical issues.

First, we analyze the evolution in trading activities of these ETFs during the period of March 2007 to December 2009 and test how ETF trading is affected by different market conditions. …

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