An Analysis of Pricing Efficiency of Exchange Traded Funds (ETFS) in India

Abstract

An ETF is a marketable security, which is traded similar to a common stock in the stock exchange that tracks an index, a commodity, or a basket of assets. ETFs are index funds representing a basket of securities, that include stocks, bonds, and other assets traded in the stock exchange. An ETF is designed to track a particular stock or bond index. Nifty Bees' based on S&P CNX Nifty, was the first ETF launched in India in the year 2001 (December) by the Benchmark Mutual Fund. The current study focuses on the pricing efficiency of equity ETFs in India. Data period was covered from the inception date of ETFs to 31st December 2018. Seventeen equity ETFs were examined in the study. The four major objectives of the study includes the pricing efficiency of ETFs and its underlying benchmark indices, the speed of adjustment of ETFs and underlying benchmark indices to its intrinsic values. Further, the study continues to examine the persistence of premiums and discounts. The study also investigates on the volatility and returns spillover between ETFs and underlying benchmark indices. The current study employs the ARDL model to examine the long-run relationship of ETFs market price and underlying index price, ETF's market price, and NAV. Also, the present study uses the ARMA estimator for assessing the speed of adjustment. Finally, the study employs the ARMA-GARCH and ARMA -EGARCH for volatility spillover of ETFs and underlying benchmark indices. Empirical results suggested that ETFs have a long-run relationship with underlying benchmark index prices, and single and multiple structural breaks had an impact on the results compared to those without structural break. The results of the second objective showed that ETFs and underlying benchmark index prices did not reflect full information in 20 days. The results of the third objective showed that most ETFs are trading in discount than premium, except a few ETFs. The bounds test result also confirmed that all the ETFs had a long-run relationship between ETF price and NAV. The finding of the fourth objective shows that volatility persistence existed in all the ETFs and their respective indices. Leverage term was negative and significant in mostvii of the ETFs and their respective indices, which further confirmed the asymmetric volatility present in the data. In most of the cases, the spillover of returns was unidirectional from index return to ETF returns and not vice versa