In this research paper, “ETF Arbitrage: Intraday Evidence,” authored by Ben R. Marshall, Nhut H. Nguyen, and Nuttawat Visaltanachoti, the focus centers on the analysis of intraday trading conditions surrounding mispricing that creates arbitrage opportunities, using two highly liquid S&P 500 Exchange-Traded Funds (ETFs).
Despite minor differences between these ETFs, not substantial enough to account for mispricing, the study reveals intriguing patterns in trading dynamics. Spreads show an increase just before arbitrage opportunities arise, indicating a concurrent decrease in liquidity. As markets become more one-sided, order imbalance intensifies, and changes in spread become more volatile, signaling a rise in liquidity risk.
The research uncovers economically significant price deviations, with a mean profit of 6.6% per annum net of spreads. Interestingly, these deviations are swiftly followed by a tendency to correct back towards parity.
The findings shed light on the intricacies of ETF arbitrage, offering valuable insights into the dynamics of mispricing, liquidity, and correction mechanisms in the intraday context.
Abstract Of Paper
We use two extremely liquid S&P 500 ETFs to analyze the prevailing trading conditions when mispricing allowing arbitrage opportunities is created. While these ETFs are not perfect substitutes, we show that their minor differences are not responsible for the mispricing. Spreads increase just before arbitrage opportunities, consistent with a decrease in liquidity. Order imbalance increases as markets become more one-sided and spread changes become more volatile which suggests an increase in liquidity risk. The price deviations are economically significant (mean profit of 6.6% p.a. net of spreads) and are followed by a tendency to quickly correct back towards parity.
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Ben R. Marshall
Massey University – School of Economics and Finance
Nhut H. Nguyen
Auckland University of Technology
Massey University – Department of Economics and Finance
In this exploration of ETF arbitrage led by Ben R. Marshall, Nhut H. Nguyen, and Nuttawat Visaltanachoti, the focus is on dissecting the intraday dynamics surrounding mispricing that opens up arbitrage opportunities.
The study employs two highly liquid S&P 500 ETFs, recognizing their imperfections as substitutes while showcasing that these minor differences are not the culprits behind the observed mispricing.
A discerning observation emerges as spreads widen just prior to the occurrence of arbitrage opportunities, aligning with a discernible decrease in liquidity. Notably, order imbalance amplifies in tandem with markets leaning towards one side, accompanied by more volatile spread changes, indicative of heightened liquidity risk.
The economic significance of the price deviations is underscored, with a mean profit of 6.6% p.a. net of spreads, emphasizing the potential gains from exploiting these mispricing opportunities. Importantly, the deviations exhibit a notable tendency to swiftly correct back towards parity.
In summary, this study illuminates the intricate interplay of factors surrounding ETF arbitrage, emphasizing the role of liquidity dynamics and market imbalances in shaping trading conditions. The observed profits, net of spreads, highlight the potential attractiveness of capitalizing on mispricing opportunities within the ETF landscape, providing valuable insights for both researchers and practitioners navigating the complexities of arbitrage strategies in the realm of exchange-traded funds.
– What is the main focus of the research paper “ETF Arbitrage: Intraday Evidence” by Ben R. Marshall, Nhut H. Nguyen, and Nuttawat Visaltanachoti?
The research paper explores the dynamics of exchange-traded funds (ETFs) and their potential for arbitrage opportunities. It uses two highly liquid S&P 500 ETFs as a basis for analysis to understand the conditions leading to mispricing and the creation of arbitrage opportunities.
– What are the key findings of the study regarding the factors contributing to mispricing in ETFs and the associated arbitrage opportunities?
The research reveals that minor differences between the analyzed ETFs are not the primary drivers of mispricing. It notes a pattern in spreads, which tend to increase just before arbitrage opportunities, suggesting a decrease in liquidity. As market conditions become more one-sided, order imbalances grow, and spread changes become more volatile, indicating an escalation in liquidity risk.
– What are the implications of the study’s findings, particularly in terms of profitability and the correction of price deviations in ETFs?
The study uncovers economically significant price deviations, with a mean profit of 6.6% per annum net of spreads, and notes a tendency for these deviations to quickly correct back toward parity. These findings provide insights into arbitrage, pairs trading, and ETFs, enhancing our understanding of the intraday dynamics of these financial instruments and their impact on market liquidity and efficiency.