The implications of ETF exchange trading for illiquid underlying markets

We examine the implications of ETF secondary market trading on corporate bonds. In 2014, the near perfect correlation between exposure to exchange trading and ETF ownership began to deteriorate. Controlling for time variation in fundamental risk, greater exposure to secondary market trading increases the comovement of bond returns. The effect is driven by exchange trading decreasing idiosyncratic risk. ETF exchange trading is unrelated to the level of systematic risk, but does increase the speed of systematic news incorporation. In contrast, ETF ownership increases idiosyncratic and systematic risk. Bonds with lower ETF exchange trading exposure overreact to downgrades compared to bonds from the same issuer