Essays on ETFs and Futures in Commodity Space: Price Discovery Dynamics and the Physical-versus-Synthetic Debate

Soner Kistak, PhD

Abstract :

Have ETFs Dethroned Futures as Price Leaders in the Kingdom of Precious Metals?: With the advent of precious metal ETFs and mini-futures in the 2000s, precious metal (PM) investment, once reserved for institutions, has become increasingly available to retail investors. This innovation has significantly increased the product choices available to gold, silver, platinum, and palladium investors. For example, physical quantities (in tons) traded through ETFs have become significant in relation to those of precious metal futures. The dominance of futures in the returns process has been well documented in the existing literature. Using the intraday data for US precious metal markets for Q2 2011, this paper examines whether there has been a change in price discovery dynamics. The analysis finds that, despite the arrival of ETFs and mini-futures, regular futures contracts still lead the price formation process in most precious metal markets, and that the contributions of ETFs and mini-futures to price discovery remain subordinate. The paper also employs Granger causality tests to investigate inter-segment interactions, and demonstrates that the returns of gold futures, silver futures, and gold ETFs have a broad impact on the returns of other PM investment vehicles. In addition, the paper looks at the stock returns of precious metal mining companies, and reveals that the returns of Barrick Gold (a gold mining company) and Silver Wheaton (a silver mining company) are partially explained by the returns of gold and silver ETFs and futures, with the role of futures being more important.

Physical versus Synthetic Commodity ETFs: Do Differences in Structures Really Matter?: The debate over Physical versus Synthetic ETFs has missed some important aspects such as secondary market dynamics and market-making. Our paper finds that as long as there is competitive and functioning market-making, the differences in structure do not constitute a problem from the point of view of investor protection. The focus of regulatory authorities should be on ensuring a fair and orderly market-making. Empirically, using intraday data our paper studies price discovery, intraday volatility, and bid-ask spreads in the secondary market for Gold, Silver, Copper, and Nickel ETF pairs (consisting of physical and synthetic ETF structures). The emphasis is put on how these instruments interact with futures. In terms of price discovery, our paper confirms the leadership of futures over both type of ETFs. This leadership of futures is more evident particularly over synthetic ETFs. Regarding intraday volatility and bid-ask spreads, we do not find systematic differences across segments in general terms. There are some differences which do not amount to generalizable findings. We explain these few differences by different levels of market-making. These relationships on the different aspects are valid under different market volatility states. In terms of bid-ask spreads, order-processing costs are the largest component while the adverse selection cost is the least important one. No particular bidask spread component is found to be leading the correlations across the bid-ask spreads.

Publication date of the thesis

Thesis committee

Supervisor: Laurent Deville, EDHEC Business School

External reviewer: Ekkehart Boehmer, SMU

Other committee member: Abraham Lioui, EDHEC Business School