Conference Agenda

We find that Exchange-Traded Funds (ETFs) are more expensive to borrow than stocks, and we provide an explanation for this difference. This phenomenon is due to features specific to the ETF lending market rather than due to the stocks the ETFs hold, as ETF loan fees tend to be higher than the average of their constituent stocks. We find that for most indices, one ETF tends to capture the majority of the short interest. This "short favorite" ETF tends to have low loan fees, while the "non-favorite" ETFs tend to be much more expensive to short and are less liquid. Demonstrating the magnitude of ETF loan fee differences within each index, we examine the returns to a within-index, cross-ETF arbitrage strategy which is profitable due to persistent loan fee differences across ETFs tracking the same index. Cross-ETF arbitrage returns are quite high and stable. Even when we partially constrain an investor’s ability to fully lend out their long position, we still find that the cross-ETF arbitrage strategy is profitable for about 2/3 of the indices in our sample. The results shed light on limits to arbitrage in the market for exchange-traded funds and provide an explanation for the high ETF loan fees that we observe.

ETFs add a new layer of market‐making to the corporate bond market that improves the market quality of the underlying bonds. Dealers use the flexibility of representative sampling in the primary corporate bond ETF market as a warehouse to manage inventory. We show that bonds with higher selling pressure are included in creation baskets increasing ETF ownership. ETF ownership increases predict credit downgrades and earnings surprises and misses in investment grade bonds. The face value of ETF holdings in investment grade bonds is 9.8% greater on the downgrade date than thirty days prior. By allowing dealers to offset inventory risk in periods of uncertainty, this new layer of market‐making leads to a negative relation between ETF ownership and idiosyncratic volatility, especially for the illiquid bonds.