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Relative Liquidity, Fund Flows and Short†Term Demand: Evidence from Exchange†Traded Funds

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  • Markus S. Broman
  • Pauline Shum

Abstract

We show that highly liquid Exchange†Traded Funds (ETFs), especially those that are more liquid than their underlying basket of securities (i.e., positive relative liquidity), are particularly attractive to investors. Using three definitions of liquidity, we find that relative liquidity predicts net fund flows, as well as inflows and outflows positively and significantly. We further document a liquidity clientele among institutional investors: (i) relative liquidity is significantly more important for short†than for long†term investors; and (ii) relative liquidity is inversely related to investors’ average holding duration in the ETFs. These two findings provide evidence that relative liquidity encourages short†term demand.

Suggested Citation

  • Markus S. Broman & Pauline Shum, 2018. "Relative Liquidity, Fund Flows and Short†Term Demand: Evidence from Exchange†Traded Funds," The Financial Review, Eastern Finance Association, vol. 53(1), pages 87-115, February.
    • Handle: RePEc:bla:finrev:v:53:y:2018:i:1:p:87-115
    DOI: 10.1111/fire.12159
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    Cited by:

    1. Kharma, Céline & Eugster, Nicolas, 2021. "Is competition beneficial? The case of exchange traded funds," International Review of Financial Analysis, Elsevier, vol. 76(C).
    2. Boutabba, Mohamed Amine & Rannou, Yves, 2022. "Investor strategies in the green bond market: The influence of liquidity risks, economic factors and clientele effects," International Review of Financial Analysis, Elsevier, vol. 81(C).
    3. Box, Travis & Davis, Ryan & Evans, Richard & Lynch, Andrew, 2021. "Intraday arbitrage between ETFs and their underlying portfolios," Journal of Financial Economics, Elsevier, vol. 141(3), pages 1078-1095.
    4. Hua Wang & Liao Xu, 2019. "Do exchange‐traded fund flows increase the volatility of the underlying index? Evidence from the emerging market in China," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 58(5), pages 1525-1548, March.
    5. Pham, Son Duy & Nguyen, Thao Thac Thanh & Do, Hung Xuan, 2022. "Effect of futures trading on the liquidity of underlying stocks: Evidence from Vietnam," Pacific-Basin Finance Journal, Elsevier, vol. 73(C).
    6. Jilong Chen & Liao Xu & Yang Zhao, 2020. "Do ETF flows increase market efficiency? Evidence from China," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(5), pages 4795-4819, December.
    7. Xu, Liao & Yin, Xiangkang & Zhao, Jing, 2019. "The sidedness and informativeness of ETF trading and the market efficiency of their underlying indexes," Pacific-Basin Finance Journal, Elsevier, vol. 58(C).
    8. Bassiouny, Aliaa & Tooma, Eskandar, 2021. "Intraday indirect arbitrage between European index ETFs," International Review of Financial Analysis, Elsevier, vol. 75(C).
    9. Rakowski, David & Shirley, Sara, 2020. "What drives the market for exchange-traded notes?," Journal of Banking & Finance, Elsevier, vol. 111(C).
    10. Atanasova, Christina & Weisskopf, Jean-Philippe, 2020. "The price of international equity ETFs: The role of relative liquidity," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 65(C).
    11. An Pham Ngoc Nguyen & Thomas Conlon & Martin Crane & Marija Bezbradica, 2024. "Herding Unmasked: Insights into Cryptocurrencies, Stocks and US ETFs," Papers 2407.08069, arXiv.org.
    12. Adam L. Aiken & D. Eli Sherrill & Kate Upton, 2022. "Side‐by‐side management of mutual funds and actively managed exchange traded funds," The Financial Review, Eastern Finance Association, vol. 57(3), pages 533-557, August.
    13. Joey W. Yang & Lewis May & John Gould, 2023. "Exchange‐traded fund ownership and underlying stock mispricing," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(S1), pages 1417-1445, April.
    14. Broman, Markus S., 2020. "Local demand shocks, excess comovement and return predictability," Journal of Banking & Finance, Elsevier, vol. 119(C).
    15. Liao Xu & Xiangkang Yin & Jing Zhao, 2022. "Are the flows of exchange‐traded funds informative?," Financial Management, Financial Management Association International, vol. 51(4), pages 1165-1200, December.
    16. Gregory Boadu-Sebbe, 2022. "Effect of Exchange-Traded Funds Arbitrage Transactions on their Underlying Holdings," CERGE-EI Working Papers wp738, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    17. Muhammad Sarmad Irtiza & Shahbaz Khan & Nida Baig & Syed Muhammad Ali Tirmizi & Ilyas Ahmad, 2021. "The turn-of-the-month effect in Pakistani stock market," Future Business Journal, Springer, vol. 7(1), pages 1-11, December.
    18. Pham, Son D. & Marshall, Ben R. & Nguyen, Nhut H. & Visaltanachoti, Nuttawat, 2021. "The liquidity of active ETFs," Global Finance Journal, Elsevier, vol. 49(C).

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