Thomas Ernst


Assistant Professor of Finance

Robert H. Smith School of Business

University of Maryland


Working Papers

Stock Specific Price Discovery From ETFs

Online Appendix

Conventional wisdom warns that exchange-traded funds (ETFs) harm stock price discovery, either by "stealing'' single-stock liquidity or forcing stock prices to co-move. Contra this belief, I develop a theoretical model and present empirical evidence which demonstrate that investors with stock-specific information trade both single stocks and ETFs. Single-stock investors can access ETF liquidity by means of this tandem trading, and stock prices can flexibly adjust to ETF price movements. Using high-resolution data on over 500 ETFs, I exploit exchange latencies in order to show that investors place simultaneous, same-direction trades in both a stock and ETF. Consistent with my model predictions, effects are strongest when an individual stock has a large weight in the ETF and a large stock-specific informational asymmetry. I conclude that ETFs do provide single-stock price discovery.

Payment for Order Flow and Asset Choice - with Chester Spatt.

This paper documents important differences in payment for order flow (PFOF), spreads, and price improvement across asset classes. In stocks, we show that PFOF is small. While many retail trades are executed off-exchange, we find that they receive meaningful price improvement, particularly when spreads are at their minimum. In single-name equity options, we show that PFOF is large. While all option trades are executed on-exchange, option exchanges have rules that facilitate internalization. We exploit variation in the Designated Market Maker (DMM) assignments at option exchanges to show that retail traders receive less price improvement, and worse prices, from those DMMs who pay PFOF to brokers, costing retail investors billions per year. Current debate concerning PFOF has focused on equity routing. We show that option routing is comparatively worse, and this gives rise to a second potential conflict of interest of brokers: encouraging customers to trade assets offering higher PFOF. As fintech has eliminated retail commissions, these cross-asset differences in PFOF have become far more consequential to broker incentives.

The Value of Off-Exchange Data - with Chester Spatt and Jonathan Sokobin.

Exploiting the structure of geographic latencies, we study the effect of trade reporting of off-exchange equity transactions and contrast that with reporting of exchange trading. Publication of off-exchange transactions by the Securities Information Processor (SIP), leads to a sharp burst in trading and quoting activity, suggesting that market participants learn from those reports, with their unique information content lingering throughout the lengthy reporting process. In contrast, there is no spike in response to SIP publication of exchange trading, but instead an earlier spike that reflects the response to the near-immediate reporting from proprietary feeds. Due to the varied locations of the off-exchange trade reporting facilities (TRFs), SIPs and exchanges, we use distinct geographical latencies to pinpoint the patterns. We document that realized spreads for the TRF-response trades are negative, consistent with these orders being informationally-motivated and contributing to price discovery.