Liquidity Of The Underlying Stocks Of ETF And Market Implicit Transaction Cost

Exchange Traded Funds (ETF) is kind of financial innovation which can be traded on theprimary market and the secondary market. For the unique liquidity feature of ETF, investors cantake index arbitrage strategy to exploit price differentials between the primary market and thesecondary market. Under the framework of market microstructure theory, this paper adoptsimplicit transaction cost as measure of liquidity of the underlying stocks of Shanghai StockExchange180ETF (SSE180ETF) to determine whether an introduction of ETF improves theliquidity of the underlying index stocks or not. To estimate the implicit transaction cost, thispaper uses a new Bayesian Gibbs estimate method, which is put forward by Hasbrouck (2009),based on daily closing prices. By contrast, our study estimates the implicit transaction cost ofall of the stocks of SSE in almost ten years. The result of this estimate also can be regarded asan empirical research on efficiency of China’s securities market.Our main finding is in the last five years, which is after the introduction of180ETF, theaverage implicit transaction cost of the SSE is increases than the number of the first five yearsand the implicit transaction cost of underlying SSE180index stocks is relatively decreases. Thatmeans the liquidity of underlying SSE180index stocks improved after the introduction of ETF.In addition, we find that the impact of an introduction of ETF is imparity on different sectorsand that a sector with a lower volatility of implicit transaction cost has a higher liquidity.Furthermore, we find that insider holdings, institutional investor holdings and equity transfermay increase implicit transaction cost, the impact of institutional investor holdings would bemore obvious. The firm which has been issued B-share and H-share has a higher implicittransaction cost because market separation and information asymmetry. Based on the abovefindings, our conclusion is the efficiency of China’s securities market is still low and theintroduction of financial innovation can to a certain extent to increase the efficiency andliquidity of securities market.