How does the Introduction of an ETF Market with Liquidity Providers Impact the Liquidity of the Underlying Stocks?.

Abstract

This article examines how the inception of an ETF market impacts several dimensions of the liquidity of the ETF-underlying-index stocks. In contrast with previous research, our evidence is based on an ETF market where liquidity providers (LPs) act as market makers. We find that: (1) the market for the underlying stocks becomes more liquid after the ETF ntroduction for investors who trade at the best-limit quotes; (2) but the stock market becomes ess deep for larger traders, most probably because some large liquidity traders exit the underlying stocks’ market for the ETF market. Some statistics suggest that those results could be related to the trading activity of ETF LPs.Transaction Costs; Exchange-Traded Fund (ETF); Index Trading;