ETFs’ two‐sided trading costs and order imbalances

Abstract

This paper proposes an integrated trading cost measure for exchange-traded funds (ETFs) that includes premiums and spreads. The measure is computed separately for buyers and sellers as the distance between the ETF's bid/ask prices and a new measure of intraday intrinsic value constructed with the ETF's daily holdings. The two-sided measure shows that order imbalances increase trading costs in the direction of the imbalance, bias midpoint quotes, and result in observed premiums and discounts. It also provides a link between these higher trading costs and the need for authorized participants to pass through the costs associated with primary market activity.

Do uninformed traders move prices? Evidence from the Bank of Japan's ETF purchasing program

“…We provide evidence of this mechanism in Appendix A. By focusing on the demand for individual stocks, we do not face issues of ETF premiums and spreads (seeLachance, 2022).6 This rule was colloquially known as the 1% rule.7 The BoJ ETF purchase program was designed "to encourage a decline in risk premiums" (seeBank of Japan, 2010). This risk reduction should occur on the announcement day of the BoJ program rather than on subsequent purchase dates.8 Over the period 2013-2015, approximately 55% of total ETF market value follows the Nikkei 225 index, while 45% follows the TOPIX index.…”