Analysis of Non-Synchronous Trading Effects on the Pricing of Exchange Traded Products

Abstract

Exchange Traded Products (ETPs) have become important members of the investment universe. They are praised by institutional and retail investors alike for their low cost, transparency and efficient pricing mechanisms. ETPs trade much like equity securities but with a unique creation and redemption mechanism which typically aligns quoted prices with the Net Asset Value (NAV) of the underlying securities. This dissertation examines a class of ETPs whose underlying reference basket consists of securities listed on stock exchanges operating in a time zone different to the time zone of the ETP instrument itself, and whose currencies of the underlying securities are different to the currency of the ETP instrument. The ETP instruments reviewed comprise of the iShares MSCI Country Series and are all listed on the New York Stock Exchange (NYSE).The ETPs are classified into three groups depending on the degree of overlap between the exchange operating times on which their underlying securities are traded and the exchange operating times of the NYSE. These groups are non-synchronous for no overlapping hours, partially synchronous for some overlapping hours and synchronous for overlapping hours.By assessing a measure of range-based volatility during 15-minute intraday intervals throughout the NYSE trading day, an understanding of the volatility profile of these ETPs is determined and analysed. It is found that non-synchronous ETPs do exhibit a higher relative level of volatility when compared to the partially synchronous group. Within the partially synchronous group, evidence of a regime-shift is observed during the period when the market of the underlying securities transitions from open to closed during the NYSE trading session. Another factor observed in the relative volatility profile is the impact of foreign exchange translation. ETPs with underlying securities priced in an emerging market currency show higher relative levels of range-based volatility. However, both emerging market and developed market denominated securities baskets exhibit relatively higher levels of volatility during the opening and closing periods of the US trading day.The results point to the need for caution and understanding of the underlying reference basket when transacting in these ETPs as investors may inadvertently transact at a price which does not reflect the fair-market value of the underlying securities basket due to price distortions as a result of volatility.