How Do ETFs Affect Stock Volatility? [Job Market Paper] [SSRN]

Abstract: I reconcile evidence in the debate on whether ETFs amplify the non-fundamental volatility of assets in ETF portfolios, by positing that heterogeneous ETFs collectively affect underlying assets through an arbitrage mechanism and a market making mechanism. Using U.S. equity ETF data, I differentiate between these two mechanisms by analyzing ETF ownership and secondary market trading. My findings reveal that seemingly contradictory evidence supporting both mechanisms co-existing, with the net effect of a new ETF modestly increasing underlying stock daily volatility by up to 2 basis points.