Benchmarking Intensity (with A. Pavlova). Revise and Resubmit at the Review of Financial Studies
Benchmarking incentivizes fund managers to invest a fraction of their funds’ assets in their benchmark indices, and such demand is inelastic. We construct a measure of inelastic demand a stock attracts, benchmarking intensity (BMI), computed as its cumulative weight in all benchmarks, weighted by assets following each benchmark. Exploiting the Russell 1000/2000 cutoff, we show that changes in stocks’ BMIs instrument for changes in ownership of benchmarked investors. The resulting demand elasticities are low. We document that both active and passive fund managers buy additions to their benchmarks and sell deletions. Finally, an increase in BMI lowers future stock returns.
Presentations: Adam Smith Workshop, AFA 2022, ASSA Meetings, EFA 2021, European Winter Finance Conference, Finance Seminar at London Business School, INSEAD Finance Symposium, Midwest Finance Association, NBER Behavioral Finance, SFS Cavalcade North America, University of Bath, Vienna Graduate School of Finance, and World Symposium on Investment Research.
Two APs Are Better Than One: ETF Mispricing and Primary Market Participation (with E. Gorbatikov).
Exchange-traded funds (ETFs) depend on arbitrageurs to correct deviations between a fund’s price and its fair value. ETFs have designated brokers, or authorized participants (APs), who have a unique right to create and redeem ETF shares, and who are thus able to perform arbitrage without risk. Using novel regulatory filings, we provide the first description of the US ETF-AP network. It has a dense core and a sparse periphery, and the observed creation/redemption volumes are highly concentrated. The level of mispricing in a US equity ETF is negatively related to the fund’s network diversity, especially during times of high market volatility. Furthermore, ETFs with a larger fraction of global systemically important banks among their APs experience higher mispricing. We theoretically show that diverse networks help mitigate the effect of shocks to AP-specific arbitrage costs. We substantiate this explanation with evidence on ETF short-selling halts and on the Federal Reserve’s purchases of bond ETFs in 2020.
Presentations: AFA 2022, Finance Seminar at London Business School, FMA 2021, NFA 2021.