Exchange Traded Funds

Moussawi and Dannhauser

Exchange traded funds, or ETFs, are a mutual fund-like product offering investors diverse exposure to the market with the added bonuses of intraday liquidity and lower trading costs, but they aren’t without limitations. Dr. Dannhauser’s research documented significant valuation effects for corporate bonds held by ETFs, while Dr. Moussawi’s work examined how ETFs exacerbate the volatility and liquidity in equity markets. Together, their work generates meaningful insights that advance the understanding of ETFs and their role in investment portfolios.

Rabih Moussawi, PhD
The Vincent B. DiDomenico Jr. ’88
Assistant Professor of Finance

Prior to becoming a thought leader and researcher at VSB, Dr. Moussawi completed his BA and MBA at the American University of Beirut, and then pursued his dream of coming to America to obtain his PhD at The University of Texas at Dallas. He also brings industry perspective, having worked for Barclays Global Investors, now part of BlackRock, and the Wharton Research and Data Services Center at The Wharton School prior to VSB.

Whereas Dr. Dannhauser focuses on the corporate bond market, Dr. Moussawi’s research examines the positive and negative consequences of the trading of ETFs in equity markets. ETFs have become appealing for liquidity and risk management purposes besides the traditional allocation needs. ETFs are being traded in high volume and very quickly. They open new venues to get long and short exposures to a variety of asset classes, styles and sectors, which creates faster price discovery and allows for better risk management.

His research has also identified unintended consequences of such innovation. “We found that the prices of stocks have become noisier and this additional layer of nonfundamental volatility is caused by ETFs. Stocks spike more frequently because they are held in the same ETF baskets that are subject to liquidity shocks and become more correlated and more sensitive to stressful market conditions,” said Dr. Moussawi. ETFs could potentially exacerbate a flash crash like in May 2010 or August 2015, leading to more risk within the market. Time will tell if these concerns about ETFs amplifying market volatility and liquidity risk are detrimental for the economy.

Even though their research has focused on different asset classes, Dr. Dannhauser and Dr. Moussawi reach similar conclusions. ETFs are being bought and sold at a blistering pace due to the unprecedented liquidity they provide, whilst arguably encouraging impulsive trading. However, the diversified exposure, price discovery, and tax efficiency of ETFs may yet yield benefits that outweigh the various costs and risks. What we can be sure of is that both professors will research these risks and pass on the lessons learned to new generations of VSB students.

Caitlin Dannhauser ’05 VSB, PhD
The Michelle and Sean Traynor ’71
Assistant Professor of Finance

Dr. Dannhauser brings to her research both an industry and academic perspective. After graduating summa cum laude in 2005 with a double major in Finance and International Business, she worked on Wall Street for Credit Suisse before pursuing her PhD in Finance at Boston College. When the time came to apply for teaching positions, Dr. Dannhauser felt a strong pull to return to VSB. “The research interests and ambitions of the department closely aligned with my own and since I started in 2015, it has been a thrill to watch the department’s research profile surge.”

Dr. Dannhauser acknowledges the seemingly positive aspects of ETFs: low-cost, diversified exposure that an investor may not otherwise be able to obtain. In particular, the ease of trading ETFs stands in sharp contrast to the illiquid market that is typical for certain asset classes, such as corporate bonds.

Despite these benefits, Dr. Dannhauser’s research focuses on potential unintended consequences of this “liquidity mismatch,” particularly in times of market turmoil. By studying the 2013 taper tantrum when US interest rates spiked significantly, Dr. Dannhauser and Saeid Hoseinzade, PhD, from Suffolk University found that the unique structure of ETFs transmits the quick trading available on the equity exchange to the underlying bonds and results in price distortions of corporate bonds, which has implications for corporations, institutional investors, and individual investors. Firms often finance investments with corporate debt while an increasing number of investors hold bond funds in their retirement accounts.

Because of these circumstances, Dr. Dannhauser suggests that market participants must weigh the upside of increased trading ability with potential pricing effects. In fact, her recent research shows that although ETF traders are considered passive investors, they are actually trading aggressively.