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The last decade has witnessed a dramatic growth in passive investing via exchange-traded funds (ETFs). To the extent that the demand for stocks via ETF flows is not related to firm-specific fundamental values, large ETF flows may push the price of the underlying stocks away from their fundamentals-based value. In this study I provide evidence consistent with this conjecture. In particular, I first document a positive association between ETF flows and the price-to-fundamentals relation of underlying stocks. Then, by using BlackRock’s expansion into the ETF business as an exogenous shock, I provide evidence that the association is likely to be causal rather than reflect some form of endogeneity (i.e., ETFs selecting certain stocks). Also, I find that high-flow firms subsequently underperform low-flow firms in operating and stock performance, consistent with the misvaluation being caused by non-fundamental demand shocks. Cross-sectional tests suggest that the ETF-related misvaluation is stronger for stocks with: a less competitive equity market (i.e., with prices more sensitive to demand shocks), lower ownership by active investors, and more costly arbitrage constraints.
Finally, I find that high-flow firms exhibit behavior typically associated with perceived overvaluation (e.g., more secondary equity offerings).
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Edition | Availability |
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Lost in the Rising Tide: Exchange-traded Fund Flows and Valuation
2019, [publisher not identified]
in English
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Edition Notes
Department: Business.
Thesis advisor: Stephen H. Penman.
Thesis (Ph.D.)--Columbia University, 2019.
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