(An) Empirical Study on The ETF Tracking Errors and Liquidity: Evidence from Korea

Abstract

This paper investigates the effect of exchange-traded fund(ETF) liquidity on ETF tracking errors , returns and volatility in the Korea. Illiquidity ETF tends to have significant tracking errors. The impact of ETF liquidity on tracking errors is different, and ETFs with optimized replications fewer tracking errors than ETFs with derivatives-used replication. In the Korean ETF market, the low trading frequency of ETFs does not necessarily affect the difference between ETF return variance and Net Asset Value (NAV) return variance. These findings suggest that illiquidity ETFs are more likely to deviate from NAV and the index, potentially implying different risks from the underlying portfolio.