The Indicative Value–Price Puzzle in ETNs: Liquidity Constraints, Information Signaling, or an Ineffective System for Share Creation?

Abstract

The prices of ETNs often significantly exceed their indicative values. Because ETNs share many features in common with zero-coupon bonds, this empirical finding is unexpected. Adopting the language of their prior research, the authors refer to this as the negative WDFD puzzle. Using a sample of 94 ETNs over the period June 6,2006, to December 31,2009, they explore three possible explanations for the negative WDFD puzzle. They find that the puzzle is not a result of liquidity constraints. In fact, increased trading volume is mildly correlated with more extreme mispricing in ETNs. The authors also find that ETN prices significantly exceeding their corresponding indicative values do not possess information about the future prospects of the asset, commodity, or index tied to the ETN. Instead, they conclude that the negative WDFD puzzle is the result of 1) uninformed, returnchasing investors and 2) a largely inefficient current system for creating new shares of existing ETNs. To work toward eliminating the negative WDFD puzzle, the authors recommend that ETN issuers who have not already done so restructure their systems for creating new ETN shares by allowing profit-motivated investors to initiate the process of share creation as they identify extreme mispricing in the marketplace. The authors also advise extreme caution to investors trading ETNs that suffer from share-creation inefficiencies because price inefficiencies are likely prevalent in such ETNs.