Pricing Efficiency and Trading Characteristics of Exchange Traded Funds : The Case of Indian Index ETFs

The present study investigates the pricing efficiency and the trading characteristics of index ETFs in India. Theoretically, ETF prices are expected to closely track their NAVs. The deviations, if any, are expected to be eliminated quickly due to the arbitrage mechanism in place. In this study, we use daily price and NAV to test the hypothesis that ETF prices can deviate significantly and persistently from their NAVs. Further, a trading profile is constructed to examine the level of trading activity in ETFs and to investigate the impact of risk management and arbitrage activities on trading volume. The findings indicate that a majority of ETFs in India exhibit large mispricing which persists over extended periods of time. There is an acute liquidity problem for a majority of the funds in the market. Finally, the study finds that trading is positively affected by market volatility, while price-NAV deviations have a negative impact on the trading volume for most of the funds. The results strongly suggest the existence of major inefficiencies in the arbitrage mechanism of ETFs