Bond Valuation Dispersion and ETF Creation

Authors

Alan Guoming Huang, University of WaterlooFollow
Russ Wermers, University of Maryland - Robert H. Smith School of Business; European Corporate Governance Institute (ECGI)Follow
Jinming Xue, Southern Methodist University (SMU) - Finance DepartmentFollow
Xing (Alex) Zhou, Southern Methodist University (SMU) - Finance DepartmentFollow

Publication Date

11-18-2024

Abstract

This paper presents a novel mechanism through which the lack of consensus on corporate bond valuation affects corporate bond ETF creation. Although multiple ETF issuers can accept the same bond during the "in-kind" creation process, they often value it differently. Valuation dispersion is driven by external pricing sources but can also reflect ETFs'efforts to minimize tracking errors. In their role as Authorized Participants (APs), dealers can benefit by delivering a bond to the ETF that values it higher while maintaining a lower overall valuation tendency. This strategic behavior benefits APs but dilutes the holdings of existing ETF investors to an extent similar to that of the funds' expense ratio.

Document Type

Article

Keywords

corporate bond, creation basket, authorized participant, liquidity, valuation dispersion, ETF

Disciplines

Finance

DOI

10.2139/ssrn.5046012

Source

SMU Cox: Finance (Topic)

Language

English