How OTC ETF Trades Can Affect Market Prices

Summary

The document asks how to quantify the price impact of trading ETFs over the counter. It contrasts a common participation-rate impact model with the possibility that ETF impact depends on how closely the market price tracks net asset value (NAV). If market price is more volatile than NAV, a large order might move the price before a market maker chooses to trade and close the gap, potentially raising costs.

It identifies several ways a counterparty might handle a trade: hold the position, trade on an exchange, match it internally, hedge, or initiate creation or redemption. These actions may have different effects on market prices. The document provides no empirical results or proposed model; it is a request for studies, specific methods, or practitioner experience. Any impact estimate would therefore need to account for the counterparty’s actions and the ETF’s price-to-NAV behavior, and the discussion alone does not establish how to do so.

Key ideas

• ETF market impact may depend on how closely its market price tracks NAV.
• A large trade could move the ETF price when market makers do not immediately close a price-to-NAV gap.
• Counterparties may hold, trade, internally match, hedge, or create or redeem ETF shares.
• The document asks for models or empirical evidence and does not provide an answer.

Tags

# What is the market impact of OTC trading ETFs?


# What is the market impact of OTC trading ETFs?












I read an interesting statement here:

> "If an ETF’s market price tracks its NAV well, it is likely to have a small market impact. On the other hand, if the market price is more volatile than the fund’s NAV, a large order could move the price before a market maker would be willing to step in and close that gap, leading to higher market impact costs."

Now, I am aware of the standard heuristic "$\beta$-exponent participation rate" market impact model as discussed by Almgren here and in this question.

With ETFs and OTC trading, the situation seems to be quite different depending on what your counterparty does. They can

- Keep the position open

- Buy/Sell the position at the exchange

- Match it with a trade of different direction (in-house)

- Hedge

- Trigger the Creation/Redemption process

Now some of these actions would directly impact the price while the others won't. The question is: Is there a way or a model to quantify market impact effects in this case?

I will be glad to accept specific models or empirical studies about this as an answer. Please do not hesitate to post your practical experience/findings (as a trader/market maker) in this topic as an answer as well!

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

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