Do Exchange Traded Funds in India Have Tracking and Pricing Efficiency?

D M V Lakshmi Velagala

doi:10.47654/v26y2022i2p1-25

Authors

VDMV Lakshmi IBS Hyderabad, ICFAI Foundation for Higher Education (IFHE) Deemed to be Univeristy Corresponding Author

DOI:

https://doi.org/10.47654/v26y2022i2p1-25

Keywords:

Exchange Traded Funds, Tracking Error, Pricing Efficiencies, Arbitrage Opportunity, Authorised Participants, Net Asset Value

Abstract

Purpose: The study investigates tracking and pricing efficiencies of selected exchange-traded funds (ETFs) in India.

Design/methodology/approach: The study applies different methods of determining tracking errors to assess tracking abilities of ETF managers; the average absolute differences, as well as the standard deviation of differences between ETF returns and benchmark returns and standard errors from the regression of ETF, returns against the benchmark. The study further uses Vector Error Correction Model (VECM) to examine the lead lag relationship between Net Asset Values (NAVs) and market prices of ETFs and pricing efficiency.

Findings: ICICI Prudential Sensex ETF exhibits the highest tracking error and Aditya Birla Sun Life Nifty ETF shows the lowest tracking error. NAVs lead their respective market prices indicating huge scope for arbitrage opportunities to authorized participants. Persistence in the deviation between NAVs and market prices is prevalent for a longer period, indicating an inefficient price discovery mechanism of the Indian ETF market. The study confirms market inefficiency in the Indian ETF market.

Originality/value: The existing literature on tracking and pricing efficiencies of ETF is largely with respect to advanced countries. There is limited evidence of such studies in the Indian context. Hence, the study adds to the literature by examining the efficient market hypothesis in the Indian ETF market in terms of tracking and pricing efficiencies.

Practical Implications: The study reveals the presence of inefficient price discovery and the scope for arbitrage. This may be due to low level of trading activity and inefficient arbitrage mechanism in India. Hence, it is the need of the hour that Securities and Exchange Board of India (SEBI) and stock exchanges should take necessary initiatives to improve trading activity in ETFs and thereby achieve market efficiency.

Keywords: Exchange Traded Funds; Tracking Error; Pricing Efficiencies; Arbitrage Opportunity; Authorized Participants; Net Asset Value

JEL Classification: G1, G2, G4

Paper Type: Research Paper

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