How trading barriers in underlying markets impact ETF trading and characteristics

Abstract

We analyze the impact of the underlying market's minimum trading unit (MTU) on the corresponding exchange-traded fund (ETF) market. We provide novel evidence, based on unique handcollected information, that establishes a correlation between market accessibility and the ETF market. MTUs represent the minimum number of shares required for a transaction and act as trading barriers for investors. Our findings indicate that institutional investors exhibit decreased involvement in ETFs when the underlying markets are less accessible. The accessibility of underlying markets is positively correlated with arbitrage activity, tracking ability, and the probability of informed trading in ETFs. Following a decrease in the underlying markets' MTUs, institutional trading activity in ETFs gradually increases. In addition, we observe significant changes in arbitrage activity, tracking ability, and the probability of informed trading in ETFs.