Title: On the Contribution of Index Exchange Traded Funds to Price Discovery in the Presence of
Price Limits without Short SellingThis paper explores the dynamics between the returns processes of an index exchange traded fund (ETF) and its relative market index when daily price movements of the underlying component stocks are constrained. Using the Shanghai Stock Exchange (SSE) 50ETF and the SSE 50 index, which comprises the 50 largest companies by market capitalization listed on the SSE, we show the SSE 50ETF significantly contributes to price discovery as measured by Hasbrouck’s (1995) information shares. More specifically, the information share of the SSE 50ETF is greater than the information share of the SSE 50 index during periods characterized by more frequent lower price limit hits. Further, regression analysis shows that, while index ETF returns respond on the day when price limits are reached, index returns respond on the day following price limits hits. Lastly, the larger the premium of the ETF price above the net asset value (NAV) of the index and the higher the proportion of price limit hits, the greater the subsequent reversal of ETF returns. Our results show index ETFs are important to price discovery of the underlying component stocks and index in the presence of imposed pricing constraints.