Underlying Valuation Uncertainty, Strategic ETF Creation and Pricing Efficiency

Authors

Alan Guoming Huang, University of WaterlooFollow
Russ Wermers, - 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 identifies a novel mechanism through which uncertainty in corporate bond valuation shapes the creation process of corporate bond ETFs. Although multiple ETFs can potentially accept the same bond during the “in-kind” creation process, they often value it differently. Such valuation dispersion is driven by fund pricing conventions and external pricing sources, but can also reflect ETFs’ efforts to minimize tracking error. Authorized Participants (APs) exploit these differences by delivering a bond to create the ETF that values it most highly. While this strategic behavior increases APs’ profits, it dilutes holdings of incumbent investors and undermines ETF pricing efficiency.

Document Type

Article

Keywords

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

Disciplines

Finance

DOI

10.2139/ssrn.5046012

Source

SMU Cox: Finance (Topic)

Language

English