Premiums and discounts of exchanged-traded funds

The objective of this study is to determine whether the spread in underlying exchange-traded fund (ETF) investments is a significant cause of the premium/discount of the ETF. Spreads of underlying investment portfolios are alternatively calculated using weighted bid-ask and bid-close spreads for a sample of ETFs listed on the Johannesburg Stock Exchange (JSE) in South Africa from 2010 to 2014. Results show that spreads of underlying investment portfolios are positively associated with larger premiums/discounts of ETFs as a whole. However, stratified results show that this relationship exists only for premiums; underlying spreads are not significantly associated with discounts. In addition, the findings show that expense ratios offer a significant explanation for premiums/discounts of ETFs. This paper contributes to the existing literature by offering an explanation for the size of premiums of ETFs at reporting date. Its findings imply that relative illiquidity in the underlying portfolio of the ETF means that a premium will likely persist. A deeper understanding in this regard assists investors in determining whether an ETF premium is worth paying for. In addition, this paper reveals that premiums and discounts of ETFs do not always arise from the same causes and should be investigated as separate phenomena in future research.