How Effective Is Arbitrage of Foreign Stocks? The Case of the Malaysia Exchange‐Traded Fund Available to Purchase

Unlike closed‐end country funds that usually trade at large premiums to the values of their portfolios, exchange‐traded funds facilitate arbitrage to prevent their prices from deviating from their underlying values. However, such arbitrage can involve significant transaction costs, which have caused some to question the ability of this arbitrage to reduce premiums. This study examines the premiums on the iShares Malaysia Fund, which is the only exchange‐traded fund that has experienced an extended suspension of arbitrage. The results illustrate the importance of arbitrage in providing the full benefits of international diversification associated with exchange‐traded funds that invest in foreign securities.