Impact Of ETF On Liquidity Of The Underlying Securities

The unique liquidity feature of ETFs that they can be traded both on the primary market through subscription and redemption and on the secondary market through order submission facilitates the diversified investment of investors, especially individual investors. ETFs succeed in distinguishing themselves from traditional closed-end funds by overcoming the problem of high degree of underpricing and low liquidity exhibited in closed-end funds. However, whether the liquidity effect of the listing of ETFs on their underlying securities is positive or negative is an important but still open question.Under the framework of market microstructure theory, this thesis adopts implicit transaction cost estimated by the model put forward by Madhavan, Richarson and Roomans (1997) as measure of liquidity of the underlying stocks of Shanghai Stock Exchange 50ETF(SSE 50ETF) to test the impact of listing of SSE 50 ETF on its component stocks'liquidity. In practice, we divide the two trading sessions of continuous auction into 48 5-minute intervals, then employ GMM to estimate the parameters in each time interval and eventually make paired and pooled comparison analyses based on these estimates. The empirical results indicate that the intraday patterns of adverse selection cost, order processing cost and implicit transaction cost of the underlying stocks exhibit L-shape, U-shape and L-shape respectively after the listing of SSE 50ETF, which is similar with that of their own counterpart before the event. Further parametric and non-parametric tests both suggest that few of the 48 intervals statistically differ in their means and medians. Therefore, the event does not change the intraday liquidity pattern of the underlying stocks. However, the means of pooled parameter estimates of adverse selection cost, order processing cost and implicit transaction cost statistically increase at 10%,1% and 1% significance levels respectively, which indicates that the liquidity of the underlying stocks declines after the event. That the listing of SSE 50ETF attracts a large portion of liquidity traders to switch from the secondary market of the underlying stocks to the trade of SSE 50ETF shares and unavoidably aggravate the issue of information asymmetry may account for the decrease of liquidity of the underlying stocks.