ETFs Tracking the S&P 500: Short-Term Demand and Comovement

Abstract

ETFs are an increasingly attractive vehicle for index investing, and part of ETF demand includes that from short-term investors. Using relative trading volume and relative liquidity, we study whether these proxies for ETF short-term demand increase the correlations of the underlying stocks. We test our hypotheses on the S&P 500 and find that increases in ETF trading activity and higher ETF relative liquidity is related to increasing constituent stock correlations. Further, we find the increase in correlations and ETF trading activity is also associated with return reversals, providing evidence that ETF trading activity imparts noise into underlying stock returns.