Can ETF's Premium Predict Its Future Returns? Based on a Perspective of Mispricing

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Journal of Central University of Finance & Economics ›› 2023, Vol. 0 ›› Issue (9) : 44-58.

XUE Ying-jie, LIU Chang-yang, WANG Yong

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Abstract

The paper depicts the formation process of ETF premium through an arbitrage equilibrium model to analyze a condition for predicting future ETF returns based on ETF premium,and examines the predictability by the method of portfolio analysis and Fama-Mecbeth regression.We find that ETF premium is a mispricing from noise shocks and investor underreaction to information,the mispricing occurs mainly at the ETF level, which implies that ETFs are much more likely to be mispriced than their underlying assets.The mispricing correction on ETF will display a negative return predictability that the future ETF return will decrease as the premium on ETF increases, and investors can gain 0.94% per week from ETF mispricing corrections by a long-short hedging strategy.Meanwhile, the ETF premium has a persistent predictive effect on future ETF return.On average, the persistence of return predictability can last for 4 weeks, which indicates that it takes at least 4 weeks for the market to fully correct ETF mispricing.In addition, we further explain the persistent predictability of ETF premiums on future returns from the perspective of arbitrage restriction, and we find that the greater the arbitrage restriction is, the longer the effect last and the higher the returns is.

Key words

Arbitrage restriction / Mispricing / ETF premium / Return prediction

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XUE Ying-jie, LIU Chang-yang, WANG Yong. Can ETF's Premium Predict Its Future Returns? Based on a Perspective of Mispricing[J]. Journal of Central University of Finance & Economics, 2023, 0(9): 44-58

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