The role of ETFs in the corporate bond market : an empirical study of potential impacts of fixed income ETFs on the underlying U.S. corporate bond market
Master thesis
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http://hdl.handle.net/11250/2561423Utgivelsesdato
2018Metadata
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- Master Thesis [4378]
Sammendrag
Exchange traded funds (ETFs) have become popular investment vehicles in the U.S. corporate
bond market. A market that is characterised by over-the-counter transactions, low liquidity
and high trading costs, is with ETFs more accessible to retail investors and arbitrageurs alike.
The ongoing trend is raising several questions from both academics and practitioners. A stream
of recent publications explores how these new, mostly passive investment vehicles are
affecting the liquidity, valuations and other aspects of the underlying markets.
We set out to investigate the effect of ETFs on the commonality of underlying bonds in the
U.S. corporate bond market. In our thesis, we examine if different measures of fixed income
ETF activity are explanatory factors of commonalities in bond returns, yields, trading volume
and illiquidity. Previous research finds that the turnover of ETF shares influences the
commonality of individual securities more compared to other ETF activity measures in the
equity market. For this reason, we additionally investigate if ETF turnover carries the same
relevance in the corporate bond market. In our empirical research we employ naïve OLS, time
series and panel regressions to investigate the relationship between ETF activity variables and
corporate bond commonality. We include both time and individual fixed effects and various
control variables in the models. Additionally, we conduct robustness tests where we add
fundamental factors that are potential drivers of bond commonalities in our time series models.
Our empirical findings suggest that there exists a relationship between ETF activity and
several commonality measures, indicating that fixed income ETFs may have an influence on
the comovement of underlying bonds. In addition, we find turnover to have the most
pronounced effect of all the included ETF measures. Implications of ETFs inducing higher
commonality could be lower diversification benefits and higher liquidity risk. As fixed income
ETFs are experiencing solid growth, further research on their implications is needed.