Exploiting Price Pressure Associated with ETF Formation

Abstract

The dramatic increase in the number of new ETFs may provide investors significant return opportunities. We examine the impact of the issuance of Merrill Lynch's HOLding Company Depositary ReceiptS (HOLDRS) on the stock prices of the HOLDRS' constituent companies. We document that HOLDR issuance requires sizeable purchases of shares in the component companies, averaging 11 percent of normal daily trading volume, and that issuance is related to significant increases in the prices of companies contained in the HOLDR-on average, a one-day market adjusted return of 3.86 percent, or equivalently a 2,000 percent annualized return. We examine the performance of six investment strategies designed to capture these price increases. These strategies, based on information publicly available at the time the strategy is implemented, earned average market-adjusted returns ranging from 2.01 percent for a 7-day holding period to 4.82 percent for an 18 day holding period.