The Impact of U.S. Exchange-Traded Fund Ownership on Underlying Chinese H-Share Volatility

Abstract

Although the presence of exchange-traded funds offers many benefits to the markets, the maturation of this asset class introduces new risks to the uninformed investor. This study tests for latent effects of US ETF ownership overseas through analysis of the volatility and pricing efficiency of underlying Chinese H-share stocks. The models in this study propose two main takeaways. First, we find that a one standard deviation increase in US country-ETF ownership decreases the average underlying Chinese stock’s volatility to a level corresponding to the 39th to 45th percentile of the sample volatility distribution. Second, I argue that increasingly higher non-fundamental demand shocks, both in magnitude and frequency, will disseminate to ETF-owned Chinese securities as the global markets get more integrated and the costs of arbitrage diminish, eventually reversing the effect found in this paper and therefore increasing underlying Chinese stock volatility. As it stands, the findings of this paper point to the notion that country-ETFs still offer additional upside to the potential US investor in need of international exposure.