Tracing financial innovation diffusion and substitution trajectories. Recent evidence on exchange-traded funds in Japan and South Korea

Since the rapid growth of the popularity of ETFs, the potential substitution between innovative financial products, exchange-traded funds (ETFs), and traditional investment funds (open-end and closed-end funds) is recognized as one of the most-discussed issues in the financial industry. This is the first study to empirically verify and compare the diffusion and substitution of ETFs using monthly data on their assets in two selected countries. The main aim of this paper is to provide in-depth insights into the development of innovative financial products available in two Asian economies: Japan and South Korea. The empirical study uses monthly total net assets data for 2004-2017. Our methodological framework combines models of innovation diffusion and technological substitution. The results reported in the study show that in both countries the diffusion of ETFs has occurred. The rate of diffusion and the phase of growth reached differed - in Japan the ETF market was in the early exponential growth stage, whereas in South Korea it was closer to achieving the expected maximum saturation. The results of the substitution analysis between the largest category of the innovative funds - equity ETFs and equity open-end funds clearly demonstrate that the process of “switching” from equity open-end funds into ETFs may be easily traced in both countries. Substitution processes were, however, gradual and reversals of the trajectories were noticed.