UC Irvine

We examine how exchange traded funds (ETFs) affect asset pricing, and turnover in a laboratory asset market. We focus on behavior in secondary markets with or without ETF assets and whether there is zero or negative correlation in asset dividends. In the latter case, the diversification benefits of ETFs are most salient. We find that when the dividends are negatively correlated, ETFs reduce asset mispricing without decreasing market activity (turnover). When dividends are uncorrelated, the ETF has no impact on these same measures. Thus, our findings suggest that ETFs do not harm, and may in fact improve, price discovery and liquidity in asset markets.