ETF Versus Cash Arbitrage and Counterparty Risk

Summary

The question asks how an exchange-traded fund and its cash or underlying exposure should move together, using gold-related instruments as an example, and what might cause them to diverge. The reply offers pointers to articles and academic research on ETF arbitrage, indicating that the topic has been studied. It does not summarize those sources, set out a quantitative method, or provide correlation estimates, so the document itself offers little basis for modeling the spread or testing a trading rule.

Its substantive caution is that an ETF may carry credit exposure through its counterparties and holdings. In a default, the investor's economic exposure could differ from the intended underlying asset; the answer illustrates this concern with the possibility of exposure to poor-quality bonds. This is a general risk warning, not a finding tied to the named gold example, and the post does not explain the ETF's structure or quantify default likelihood or loss. Any arbitrage analysis would need to examine the fund's actual assets, counterparties, and creation and redemption arrangements alongside price deviations.

Key ideas

• ETF and underlying prices may diverge, but the post provides no quantitative account of the relationship.
• The reply points to existing articles and research on ETF arbitrage without summarizing their methods or findings.
• ETF structure can introduce counterparty and credit exposure that differs from direct ownership of the underlying.
• An arbitrage assessment should account for the fund's holdings and counterparties as well as observed price spreads.

Tags

# What are some quantitative method behind etf vs cash arbitrage?


# What are some quantitative method behind etf vs cash arbitrage?












Has there been any studies done on the correlation between etf vs cash (i.e. GLD vs GD) for example and how they should theoretically move together, and what fundamental reasons could cause them to diverge.

## Answer by SRKX (score 7)

https://quant.stackexchange.com/a/2559

A quick Google search gives a few hints:

- http://etf.about.com/od/etfinvestingstrategies/a/ETF_Arbitrage.htm

- http://ftalphaville.ft.com/blog/2011/05/18/572086/how-profitable-is-etf-arbitrage/

- http://www.iijournals.com/doi/abs/10.3905/jii.2010.1.1.107

- http://seekingalpha.com/article/68064-arbitrage-opportunities-with-oil-etfs

Another quick search on scholar.google.com gives this research.

So some work has been done on the topic. However, I'd warn you about the credit risk of the ETF, as countre-parties are various, often unknown and might be really unreliable, and you might end up with a portfolio of junk bonds rather than the underlying your were looking for in case of default.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.