The aim of this paper is to examine the informational efficiency of prices of all exchange traded funds (ETFs) that are actively traded on the NYSE Arca, based on methodology developed by Chordia et al.
The authors estimate the speed of convergence to market efficiency based on short‐horizon return predictability from past order flows of 273 ETFs that were traded every day on the NYSE Arca during the first six months of 2008, and compare the resulting price formation process to that of shares traded on the NYSE and NYSE Arca.
Despite the significant differences in trading costs, volatility, and informational effects between ETFs and regular stocks, the paper documents that price adjustments to new information for ETFs occur in about 30 minutes, which is comparable to price adjustments for traditional stocks traded on Arca. In multivariate setting, the paper further shows that the speed of convergence to market efficiency of ETFs is not only significantly driven by volume, but also by the probability of informed trading.
The findings provide direct answers and insights to questions posed in a recent SEC concept release document. The analysis of the speed of convergence provides a feasible measure to assess how efficiently prices of ETFs respond to new information.
The authors are first to utilize the short‐horizon return predictability from historical order flow approach to evaluate the price formation process of ETFs and to provide evidence on the determinants of its efficiency.
