Center for Industrial Mathematics and Statistics » REU 2015

Jonathan Beall

Kelli Dowd

Rivers Jenkins

Zoe Rehnberg

Overview

Industrial Sponsor: Dr. Ritripua Samanta - State Street Global Advisors

Faculty Advisor: Marcel Blais

An exchange traded fund (ETF) is a security that represents an underlying collection of assets and trades with stocks throughout the day on an exchange. ETFs provide easy diversification for investors as well as a more liquid market for positions dependent on the underlying assets. Liquidity in these ETF markets is an important issue for financial institutions like State Street Global Advisors (SSgA) who must manage risk and participate in the buying and selling of assets in these markets. In illiquid markets, large transactions can result in high trading costs due to illiquidity or even an inability to completely liquidate the necessary assets in the necessary time frame. In order to accurately assess the liquidity in the underlying basket, these financial institutions rely on liquidity metrics that model and track changes in liquidity over time. One such metric was developed in 2014 by the Worcester Polytechnic Institute Financial Math REU team that considers differences between the ETF share price and the net asset value (NAV) or price per share of the basket of underlying assets. Because these two values are both based on the same securities, the price difference between them can be attributed solely to a difference in liquidity. The ETF-NAV Liquidity Metric (ELM) that was developed exploits this price difference to quantify the liquidity of the underlying assets. In our work, we expand ELM beyond simple considerations of ETF price and NAV to include the effects of market depth and time-to-liquidation. While expanding the model we focus on high risk, high yield bond ETFs like SSgA's JNK, though we expect that the methods can be applied to a wider range of ETFs.