The effect of liquidity and time-lag on ETF discounts and ETF return predictability
Hyttinen, Tomi (2011)
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The purpose of the thesis is to discover if liquidity and time-lag between the ETF market and its NAV market affects the ETF discount. Also if ETF discounts are able to predict future ETF returns. Previous studies have focused on show-ing the relation between ETF discounts and future ETF returns as well as to specifically examine the ETF discount, its informational value and reasons to cause it. None of the previous studies have, however, directly studied liquid-ity´s or time-lag´s impact on the ETF discount or on the phenomenon how the ETF return/discount relation changes when the time-lag increases. As data in this thesis is used 8 international ETFs traded in the New York Stock Exchange. The period for the study is July 14, 2000 – January 19, 2011. The data is daily data excluded days, when the exchange either in the ETF market or its NAV market has been closed. The results from the empirical part show, that liquidity has no significant effect on the ETF discount. Also discovered, that the ETF dis-count is not directly correlated with the increasing time-lag. Instead is discov-ered, that lagged ETF discounts can explain future ETF returns. Lagged ETF discounts are found to be a positive predictor for the future ETF returns at time t-1. However, the more lag is involved, the less the ETF discount acts as a posi-tive predictor for the future ETF returns.