Abstract
ETFs have become the widely traded financial derivatives in the international markets. Literature about ETFs are increasing and increasing. The paper finds that different payment forms of ETFs dividends significantly affect funds’ tracking error between Taiwan and foreign markets. Past literature assumed ETFs and index converge after ETFs pay out dividends, meaning that ETFs pay out all dividends accumulated in funds to investors. However, Taiwan ETFs market is not the same as American ETFs markets. Because of restriction on the distribution of dividends and bad performance, ETFs investors may suffer dividends loss in the long run. The paper takes five ETFs for research, including Taiwan Top 50 ETF, Mid-Cap 100 ETF, Dividend Plus ETF, Elec Tech ETF, Fubon Financial ETF. Taiwan Top 50 ETF investors face 6.44 dollars loss per share since public issuing, Mid-Cap 100 ETF 1.56 dollars, Dividend Plus ETF 1.75 dollars, Elec Tech ETF 4.79 dollars, Fubon Financial 1.64 dollars. Accumulated dividend gaps between ETFs and index will further affect tracking error of ETFs. Thus, the paper assumes investors reinvest ETFs, comparing with the return index. We re-define tracking error as the difference between returns of reinvestment performance and return index, deleting effect of dividends. We find that no matter one, two, three or five-year tracking errors are statistically significant. Investors shouldn’t ignore. Tracking errors of five ETFs analyzed are all less than zero, meaning that reinvestment performance is less than return index performance. Taiwan Top 50’s one-year tracking error is -0.77%, Mid-Cap 100 -0.07%, Dividend Plus -0.41%, Elec Tech -1.02%, Fubon Financial -0.67%. Tracking errors of Taiwan Top 50 ETFs and Dividend Plus ETFs are max in two-year basis, with Taiwan Top 50 -1.75%, Dividend Plus -1.25. Tracking errors of Taiwan Top 50 ETFs and Elec Tech ETFs are max in three-year basis, with Taiwan Top 50 -2.68%, Elec Tech -2.58%. Elec Tech ETF’s tracking error is max in five-year basis, up to -5.03%. Finally, it is generally believed that ETFs may reduce arbitrage costs and therefore promote pricing efficiency of futures market. Thus, we use cost of carry model to analyze Taiwan 50 futures pricing efficiency. The empirical results show that Taiwan 50 futures pricing is inefficient, t-test is statistically significant. However, two-parent test of pricing error in index and ETFs confirms ETFs does significantly reduce the futures pricing error. In addition, dividend yield significantly impacts on the tracking error. The higher the dividend yield, the more difficult to predict, errors are bigger.