Three essays on the microstructure of exchange traded funds

Exchange traded funds (ETFs) have increased significantly in popularity since they were first introduced in 1993. However, there is still much that is unknown about ETFs in the extant literature. This dissertation attempts to fill gaps in the ETF literature by using three related essays. In these three essays, we compare ETFs to closed ended mutual funds (CEFs) by decomposing the bid-ask spread into its three components; we look at the intraday shape of ETFs and compare it to the intraday shape of equities as well as examine the co-integration factor between ETFs on the London Stock Exchange and the New York Stock Exchange; we also examine the differences between leveraged ETFs and unleveraged ETFs by analyzing the impact of liquidity and volatility. These three essays are presented in Chapters 1, 2, and 3, respectively. ^ Chapter one uses the Huang and Stoll (1997) model to decompose the bid-ask spread in CEFs and ETFs for two distinct periods—a normal and a volatile period. We show a higher adverse selection component for CEFs than for ETFs without regard to volatility. However, both ETFs and CEFs increased in magnitude of the adverse selection component in the period of high volatility. Chapter two uses a mix of the Werner and Kleidon (1993) and the Hupperets and Menkveld (2002) methods to get the intraday shape of ETFs and analyze co-integration between London and New York trading. We find two different shapes for New York and London ETFs. There also appears to be evidence of co-integration in the overlapping two-hour trading period but not over the entire trading day for the two locations. The third chapter discusses the new class of ETFs called leveraged ETFs. We examine the liquidity and depth differences between unleveraged and leveraged ETFs at the aggregate level and when the leveraged ETFs are classified by the leveraged multiples of -3, -2, -1, 2, and 3, both for a normal and a volatile period. We find distinct differences between leveraged and unleveraged ETFs at the aggregate level, with leveraged ETFs having larger spreads than unleveraged ETFs. Furthermore, while both leveraged and unleveraged ETFs have larger spreads in high volatility, for the leveraged ETFs the change in magnitude is significantly larger than for the unleveraged ETFs. Among the multiples, the -2 leveraged ETF is the most pronounced in its liquidity characteristics, more so in volatile times. ^