Are US-Dollar-Hedged-ETF investors aggressive on exchange rates? A panel VAR approach

• The ETF industry is a prime example of financialization.
• This study examines the financialization impacts of ETFs due to investor behavior.
• Granger-causality tests indicate that these investors proactively trade US listed currency hedged ETFs before large real exchange rate movements.
• Investors have more of a reaction to changes in foreign exchange rates than to changes in the underlying benchmark.
• The use of ETFs to hedge against exchange rate volatility may have itself become a source of volatility.

Exchange traded funds (ETFs) are a multi-trillion dollar market that epitomizes financialization due to its recent growth. This study examines the behavior of U.S. listed currency hedged ETF investors towards changes in the underlying benchmark and foreign exchange rate from July 2011 to November 2015 using a panel VAR approach. We find that investors are able to anticipate changes in future exchange rates and invest in currency hedged ETFs prior to changes. Granger-causality tests confirm that these investors proactively trade before large real exchange rate movements. These results suggest that the use of financial instruments such as ETFs to hedge against exchange rate volatility may have itself become a source of volatility, which have implications for the further financialization of the ETF industry.

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