ETFs and the price volatility of underlying bonds

Abstract

We investigate whether exchange traded funds (ETFs) distort bond prices or increase price volatility. Contrary to concerns, we find that ETF ownership of corporate bonds is linked to reduced price volatility, likely due to ETFs absorbing bond illiquidity. Monthly net ETF inflows (outflows) increase (decrease) volatility for investment-grade bonds but have no effect on high-yield bonds. Additionally, daily ETF flows negatively correlate with same-day bond returns. Overall, our results suggest that bond ETFs enhance market efficiency, acting as a liquidity buffer rather than contributing to demand pressure as seen with stock ETFs.