The impact of security concentration on adverse selection costs and liquidity: an examination of exchange traded funds

We examine the determinants of liquidity and adverse selection costs in a sample of basket securities. Using Exchange Traded Funds (ETFs), we find evidence that adverse selection costs are decreasing in the number of equities held in the underlying portfolio, but adverse selection costs do not incre...

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Bibliographic Details
Published in:Journal of economics and finance 2012-04, Vol.36 (2), p.261-281
Main Authors: Small, Kenneth, Wansley, James, Hood, Matthew
Format: Article
Language:English
Subjects:
Adverse Selection
American dollar
Cost reduction
Discounts
Economics
Economics and Finance
Estimates
Exchange Traded Fund (ETF)
Exchange traded funds
Finance
G00
Impact analysis
Liquidity
Macroeconomics/Monetary Economics//Financial Economics
Mutual funds
Securities markets
Stock exchanges
Stocks
Studies
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Summary:We examine the determinants of liquidity and adverse selection costs in a sample of basket securities. Using Exchange Traded Funds (ETFs), we find evidence that adverse selection costs are decreasing in the number of equities held in the underlying portfolio, but adverse selection costs do not increase as the concentration among the securities increases. We find no evidence that industry concentration increases basket security adverse selection costs or reduces liquidity. We also document significantly lower levels of adverse selection costs in ETFs versus a matched sample of equities. In addition, ETFs have quoted dollar depth that is 35 times larger than a matched sample of equities, but ETFs also have higher effective and quoted spreads. However, when considering spreads and depth in a single metric, ETFs have significantly higher levels of liquidity.
ISSN:1055-0925
1938-9744
DOI:10.1007/s12197-009-9117-z