Spillover and leverage effect in Smart Beta Exchange Traded Funds: Evidence from India

Abstract

This study is unique in examining the spillover and leverage effect of Smart Beta Exchange Traded Funds (SB ETFs) and their underlying indices and Cap-Weighted (CW) indices. We find unidirectional return spillover from most SB ETFs to CW indices and bidirectional return spillover between SB ETFs and SB indices using VAR/VECM model. Besides, we find that information is transmitted faster from SB ETFs to the indices than from indices to SB ETFs. Interestingly, we observe that innovations in SB ETFs explain 97% of variance in SB indices and 81% of variance in CW indices. Hasbrouck’s information share of SB ETFs is highest (88%) followed by CW indices (5.6%). ARIMA-GARCH model shows that bidirectional volatility spillover exists between SB ETFs and the indices. ARIMA-EGARCH model provides evidence of leverage effect in SB ETFs, highlighting that volatility increases more after negative shocks than after positive shocks. Our study provides evidence of greater information transmission from SB ETFs to SB indices and to CW indices.