Can ETFs afect U.S. fnancial stability? : A quantile cointegration analysis

This study evaluates whether exchange traded funds (ETFs) threaten fnancial market stability by testing two hypotheses relating the growing importance of ETFs to increased market volatility and rising equity valuations. We estimate quantile cointegration models using Standard & Poor's 500 Index (S&P 500) and Chicago Board Options Exchange volatility Index (VIX) data for 1994-2020. We found that an increase in ETFs is positively and signifcantly related to the long-term valuation of the S&P 500 for quantile values above the median. By contrast, ETFs have only a negative and signifcant efect on the VIX for quantiles around the median. Ultimately, two novel results were obtained. First, the distortion in the value of the S&P 500 relative to its fundamentals is driven by investor fow into ETFs during a bull market. Second, the impact of equity ETFs on the VIX is only afected when fundamental factors are in play, decreasing it. Therefore, ETFs contribute to forming equity bubbles and support valuation market dynamics. Both regulators and policymakers should consider these conclusions.