Since the introduction of ETFs in Korea in October 2002, Korea’s ETF market has shown rapid growth and is fourth largest in the world as of June 2012 in terms of intraday trading volume. The ETF market maintains strong growth, while Korea’s stock market is sluggish overall. On the other hand, there are concerns over growing potential risks in accordance with the increasing assets under management and trading volume of ETFs. Blamed for increasing stock market volatility, ETFs can also trigger liquidity risks, counterparty risks, etc,in case of a large-scale redemption affected by financial market instability. For this reason, international organizations including the FSB are engaged in lively discussions on ETF regulation.
With all these aspects being taken into consideration, the current status of domestic and overseas ETFs is examined and their potential risk factors are closely checked in this paper. In addition, the recent surge in trading volume of levereaged ETFs in Korea prompted the authors to conduct an analysis on the effect of leveraged ETFs, which account for most of the total trading volume, on stock market volatility. The analysis of the KOSPI 200 index and futures prices during the periods before and after the introduction of KODEX Leveraged ETF, a typical leveraged ETF product, in February 2010 shows that, before its inception, stock prices moved in the direction opposite to the daily trend during periodic call auctions before market closing. After the introduction, however, the upward/downward trend of the day was seen with statistical significance to persist during the auctions. Leveraged ETFs are interpreted as working as a factor increasing the daily volatility of the entire stock market since leveraged ETFs undergo a process called daily rebalancing whichamplifies the intraday price movementof the market.
The ETF market in Korea is expected to continue to grow rapidly into the future, boosted largely by individual investors’ preference for index fund investments, increased investment by institutional and foreign investors, the development of various ETF products, and an increased supply of foreign ETFs listed on the Korean stock market. Since overdependence on a particular ETF or market growth driven solely by derivative-based ETFs may disturb the stock market and undermine the financial markets, efforts are required to develop sound measures to nurture the ETF market in keeping with its quantitative expansion.