Tracking Ability of ETFs: Physical versus Synthetic Replication

Abstract

The purpose of this study is to examine the tracking ability of physical (in-kind) and synthetic (swap-based) exchange traded funds (ETFs). By using three different measures of tracking error, I examine ten pairs of ETFs, which on aggregate track different asset classes (equities, bonds, commodities, and foreign exchange rates), are sponsored by several investment companies and are listed on various stock exchanges. For consistency though, each pair under review tracks the same underlying index/asset, trades on the same stock exchange and is denominated in the same currency.