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ETFs Extinguishing Stock Anomalies?

April 21, 2022 • Posted in Equity Premium

Has the quick reaction of exchange-traded funds (ETF) to marketwide news made the stocks they hold more efficient than other stocks, thereby suppressing the strength of anomalies in stocks held? In their March 2022 paper entitled “ETFs, Anomalies and Market Efficiency”, Ilias Filippou, Songrun He and Guofu Zhou investigate effects of ETF ownership within the holdings of previously constructed hedge (long-short) portfolios for 205 stock return anomalies. Each month, they:

  • For each anomaly:
    • Partition holdings of each anomaly hedge portfolio into equal-weighted high, middle and low ETF ownership groups.
    • Compare performances of the high and low groups.
  • To aggregate anomalies:
    • Subtract the number of times a stock appears in the short sides of the 205 individual anomaly hedge portfolio holdings from the number of times it appears in the long sides to obtain net stock mispricing scores. 
    • Reform a hedge portfolio that is long (short) the tenth of stocks with the highest (lowest) mispricing scores.
    • Partition this aggregate anomaly hedge portfolio into equal-weighted high, middle and low ETF ownership groups.
    • Compare performances of the high and low groups.

Using monthly data for a broad sample of U.S. stocks, 1,509 U.S. equity ETFs and the 205 anomaly hedge portfolios during January 2000 through December 2020, they find that: (more…)

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