The Impact of Innovation: Evidence from Corporate Bond ETFs

Using distinct features of corporate bond ETFs, financial innovation is found to have a significant and long-term positive valuation impact on the systemically important underlying. A one standard deviation increase in ETF ownership reduces high yield and investment grade bond spreads by 20.3 and 9.2 basis points, respectively, implying an average monthly price increase of 1.03 % and 0.75%. Two novel quasi-natural experiments exploit exogenous changes in ETF eligibility to confirm the effect. Examining theoretical explanations for the effect, ETFs are found to decrease liquidity trader participation, increase institutional ownership, and insignificantly or negatively impact the liquidity of individual bonds.