Impact of leveraged ETF trading on the market quality of component stocks

• We examine how leveraged ETF trading affects the trading of their component stocks.
• Spreads of component stocks increase about 0.2–0.3 basis points after ETF inceptions.
• Other liquidity measures do not show significant changes.
• The trading volumes of leveraged ETFs and the stocks are positively correlated.
• The volatility of component stocks is not affected by leveraged ETF trading.

We investigate the effect of leveraged ETF trading on the trading activity and market quality of their component stocks. The results show that both quoted and effective spreads of component stocks increase about 0.2–3.0 basis points after the inception of leveraged ETFs, while other liquidity measures do not show significant changes. The trading volume of component stocks is positively and significantly correlated with the trading volume of leveraged ETFs, but the volatility of component stocks is not affected by ETF trading either at the daily level or during the last hour of trading. In addition, the volatility of component stocks decreases slightly after ETF inception. These findings do not support the previous claim that the trading of leveraged ETFs increases price volatility of component stocks.