We examine a unique phenomenon where exchange-traded funds (ETFs) in the Chinese stock market pervasively participate in IPOs to profit from underpricing. The ETF IPO participation passes primary market benefits (about 4.56% per annum) to investors, providing benefits from hard-to-reach investment opportunities. These moves showing ETFs are not entirely passive highlight the benefits of ETFs' active management. However, this activity leads to increased non-fundamental volatility and short-term return reversals among ETF member stocks, representing negative externalities. We use a policy shock as a quasi-natural experiment to establish causality, highlighting the dual nature of ETFs' active management.

zlynne@ceibs.edu