Abstract Non-fundamental demand shocks have significant effects on asset prices, but observing these shocks is challenging. We use the exchange-traded fund (ETF) primary market to study non-fundamental demand. Unique to the ETF market, specialized arbitrageurs called authorized participants correct violations of the law of one price between an ETF and its underlying assets by creating or redeeming ETF shares. We show theoretically and empirically that creation and redemption activities (ETF flows) provide signals of non-fundamental demand shocks. A portfolio that is short high-flow ETFs and long low-flow ETFs earns excess returns of 1.1–2.0% per month, consistent with non-fundamental demand distorting asset prices away from fundamental values. Moreover, we show non-fundamental demand imposes non-trivial costs on investors, leading to underperformance.

Abstract We consider a macroprudential approach to analyze the optimal lending policy for the central bank, focusing on spillover effects that policy exerts on money markets. Lending against high-quality collateral protects central banks against losses, but can adversely affect liquidity creation in markets since high-quality collateral gets locked up with the central bank rather than circulating in markets. Lending against low-quality collateral creates counterparty risk but can improve liquidity in markets. We illustrate the optimal policy incorporating these trade-offs. Contrary to what is generally accepted, lending against high-quality collateral can have negative effects, whereas it may be optimal to lend against low-quality collateral.