Analysis of Exchange-Traded Funds Pricing Deviations and Tracking Errors: Evidence from U.S. Market

• Název práce v češtině: Analýza cenových odchylek a sledovacích chyb ETF fondů: Případ amerického trhu
• Název v anglickém jazyce: Analysis of Exchange-Traded Funds Pricing Deviations and Tracking Errors: Evidence from U.S. Market
• Klíčová slova: ETF fondy, cenové odchylky, sledovací chyby
• Klíčová slova anglicky: Exchange-Traded Funds, Pricing Deviations, Tracking Errors
• Akademický rok vypsání: 2019/2020
• Typ práce: bakalářská práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: Mgr. Petr Polák, M.Sc., Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 09.06.2020
• Datum zadání: 09.06.2020
• Datum a čas obhajoby: 24.01.2022 09:00
• Datum odevzdání elektronické podoby: 04.01.2022
• Datum proběhlé obhajoby: 24.01.2022
• Oponenti: doc. PhDr. Jozef Baruník, Ph.D.

Seznam odborné literatury

Agapova, A. (2011). Conventional mutual index funds versus exchange-traded funds. Journal of Financial Markets, 14(2):323–343.

DeFusco, R.A., Ivanov, S.I. & Karels, G.V. (2011). The exchange traded funds’ pricing deviation: analysis and forecasts. Journal of Economics & Finance 35, 181–197

Elton, E.J., Gruber, M.J., Comer, G., Li, K., 2002. Spiders: where are the bugs? Journal of Business 75, 453–472.

Elton, E.J., Gruber, M.J., Brown, S.J., Goetzmann, W.N., 2006. Modern Portfolio Theory and Investment Analysis, 7th ed. John Wiley & Sons, Inc.,

Harper, J.T., Madura, J., Schnusenberg, O., 2006. Performance comparison between exchange-traded funds and closed-end
country funds, Journal of International Financial Markets. Institutions & Money 16, 104–122.

Lettau, Martin, Madhavan, Anath. 2018. Exchange-Traded Funds 101 for Economists. Journal of Economic Perspectives, 32 (1): 135-54.

Madhavan, Anath , Sobczyk, Alexander (2016). Price dynamics and liquidity of exchange-traded funds. Journal of Investment Management 14, 86-102

Poterba, J. M. and Shoven, J. B. (2002). Exchange traded funds: A new investment option for
taxable investors. Technical report, National Bureau of Economic Research.

Předběžná náplň práce v anglickém jazyce

Research question and motivation:

The main research question of the thesis is to study the price deviation of Exchange Traded Funds (ETFs) from its underlying indices and how is this phenomenon affected by the structure of the ETF. Specifically, I will be interested in the effect of dividend policies of the companies included in the index. In addition, I will examine the role of ETFs comprised of companies consistently paying high dividends (dividend aristocrats) in portfolio and compare their performance against ETFs following general market indices.

Exchange Traded Funds are considered as one of the biggest innovations in the world of finance in the recent years. Since 1993, when the first US-listed ETF tracking the S&P 500 index (SPDR) was introduced, the market had grown substantially both in terms of value and diversity. As of April 2020, there were US$5.8 trillion of ETF assets worldwide, which represent approximately 6.4 % of the global equity market (BlackRock, 2020). This naturally resulted in increased attention and curiosity of investors, researchers and regulators.

Due to its similarities, ETFs are often discussed as a competitor to open-end index mutual funds (OEFs). Poterba & Shoven (2002) shows that between 1994 and 2000 the performance of the SPDR (ETF) and Vanguard Index 500 (OEF) which both aim to follow S&P 500 index (in terms of pre-tax and after-tax returns) were very similar. Agapova (2009) argues, that these two investment vehicles are substitutes, however not perfect substitutes. Together with its cost and tax effectiveness, this evince that ETFs may be a good way for an investor, to hold wide and diversified basket of financial assets.

Several studies, e.g. Elton et al. (2002) or Harper et al. (2006) are addressing the performance of ETFs in tracking the related indices and finds signs of tracking errors, Defusco, Ivanov & Karels (2011) shows that the price deviation is predictable.

My thesis aims to enhance the current state of knowledge mainly by analyzing some of the aforementioned aspects on specific class of ETFs and to discuss whether it is a good investment instrument given its characteristics.

Contribution:

Existing research suggests that there is a difference between the price of the ETF and the tracked market index. Defusco, Ivanov & Karels (2011) shows that the creation and redemption of ETF units, and the lack of a direct way to trade an index leave predictable and nonzero deviation, namely a pricing deviation which can be considered an additional cost of administering the ETF. In particular, they found relationship between the deviation and accumulation of dividends. Madhavan and Sobczyk (2016) proposes also other important factors such as number of stocks in the index or liquidity measures. The above stated suggests that some types of ETFs may have systematically bigger pricing deviations than others.

I will specifically analyze, if there is a difference in the pricing deviation between funds following indices comprised of companies paying high dividends and funds following general markets such as S&P 500, NASDAQ or DJI, and how is that determined. Additionally, the dividend ETFs will be compared to other ETFs in terms of their returns and volatility to identify their potential role in portfolio.

Methodology:

I am going to use daily ETF and stock trading data. Such data can be easily obtained from databases like Thomson Reuters or Yahoo Finance. Additional information about the ETFs will be taken from the websites of their issuers or screeners (e.g. justETF.com). This will form a panel-structure dataset which will be analyzed.

For studying the price deviation, OLS regression model will be formed, considering the dividend policies and possibly other important factors. For examination of performance of the dividend ETFs and their role in portfolio, I expect to use CAPM model and commonly used indicators (Sharpe ratio, Jensen’s Alpha, expense ratios, etc.…). Additionally, the index tracking errors will be computed and compared.

Outline:

1. Abstract
2. Introduction
3. Literature overview
a. Description of ETFs
b. Overview of available knowledge and existing research
4. Data & Methodology
a. Description of the data
b. Methods used
5. Empirical analysis
a. Pricing deviation analysis
b. Performance of dividend ETFs
6. Results
7. Conclusion
8. References