Liquidity Creation by Exchanged-Traded Funds

This project aims to quantify the value of liquidity created by exchange-traded funds (ETFs) for retail investors. The measure of liquidity creation, originally from Chernenko and Doan (2022), compares the costs to retail investors of trading on their own in response to liquidity shocks with the costs incurred by ETFs when trading in response to fund flows. The introduction and increasing popularity of ETFs have provided retail investors with a cost-effective means to gain exposure to the broad financial markets. Several studies have examined the impact of ETFs on the trading of underlying assets, identifying both positive and negative effects. However, none of these studies have directly assessed the specific costs or benefits that retail investors derive from investing in these investment vehicles. Therefore, this project seeks to quantitatively measure the value of liquidity creation by ETFs in the U.S. municipal bond markets. Furthermore, it aims to provide further evidence and recommendations on how policy makers can effectively regulate ETFs to ensure the best outcomes for retail investors and maintain overall financial market stability.