Professor Francesco Franzoni, University of Lugano and the Swiss Finance Institute
We study whether exchange traded funds (ETFs) impact the volatility of their underlying stocks. Using mechanical variation in ETF ownership, we present evidence that stocks owned by ETFs exhibit significantly higher intraday and daily volatility. A one standard deviation higher ETF ownership is associated with daily stock volatility higher by 16 per cent. The driving channel appears to be arbitrage activity between ETFs and the underlying stocks. The effects are stronger for stocks with high limits to arbitrage. Finally, the evidence that ETF ownership increases stock turnover suggests that ETF arbitrage adds a new layer of trading to the underlying securities.