Decimalization, Trading Costs, and Information Transmissions between Etfs and Index Futures

We examine the impact of decimalization on the relative changes in trading costs, informed trading, and speed of information transmissions between Exchange Traded Funds (ETFs) and their corresponding index futures. The quotes of ETFs are decimalized on January 29, 2001, while those of index futures are not. We examine whether the decrease in the minimum tick size of ETFs influences the relative performances of both securities in the price discovery process. We find that for ETFs, the trading activity increases, but the market depth drops significantly after decimalization. The spreads for ETFs and index futures generally decrease. The adverse selection component of ETFs' spreads increases, while that of index futures decreases. Furthermore, we find that ETFs start to lead index futures and its share of information also increases after decimalization. Although index futures still assume a dominant role in information discovery, the efficiency of the ETFs' prices seems to improve significantly after decimalization