This paper shows that authorized participants’ (APs) regulatory constraints weakened the arbitrage relationship between bond ETFs’ primary market activity and their premia during the market turmoil triggered by the dash-for-cash episode in March 2020. Arbitrage activity weakened more severely when those APs with a history of creating or redeeming an ETF’s shares had low regulatory capital ratios, consistent with persistence in arbitrage activity. The results also reveal that the direction of prior arbitrage activity matters, and show that the decline in arbitrage intensity was especially pronounced for ETFs holding less liquid bonds, whose lead market makers had lower regulatory capital ratios, and for those associated with non-bank-affiliated APs. Finally, the paper provides a novel estimate of the elasticity of primary market activity to ETF premia, contributing to the literature on limits to arbitrage and intermediary frictions

Frequent, yet uninformed, market timing recommendations by a financial advisory firm generate significant flows for Chilean pension funds. These flows induce substantial changes in the Chilean foreign exchange rate due to the funds’ high allocation to international securities. Local banks provide liquidity to pension funds in the spot market and their hedging transactions propagate the demand fluctuations from the spot to the forward market, resulting in deviations from covered interest rate parity. Using bank balance sheet data, we confirm that banks’ risk bearing constraints create limits to arbitrage

We examine a link between bond exchange-traded fund (ETF) creation and redemption processes and the underlying bond market liquidity. Using daily creation and redemption data, we find that including a bond in a creation or redemption basket has a favorable impact on the bond’s liquidity for both high-yield and investment-grade markets. The improvement in liquidity persists during times of market stress with this impact being stronger for redemptions than creations. Our results suggest that ETF mispricing arbitrage explains the improvement in bond liquidity. However, we also find evidence that transaction costs and bond inventory management limit the ETF arbitrage

This paper shows that leading theories of the beta anomaly fail to explain the anomaly’s conditional performance. Abnormal returns and Sharpe ratios of betting-against-beta (BAB) factors rise following months with below-median realized volatility, even controlling for mispricing, limits to arbitrage, lottery preferences, analyst disagreement, and sentiment. Moreover, the leverage constraints theory counterfactually predicts that market and BAB Sharpe ratios increase with volatility. We further show that institutional investors shift their demand from high- to low-beta stocks as volatility increases, and the resulting price impact is sufficient to explain the difference in abnormal BAB returns between high- and low-volatility states