ETFs' two-sided trading costs and order imbalances

This paper proposes an integrated trading cost measure for exchange-traded funds (ETFs) that includes premiums and spreads. The measure is computed separately for buyers and sellers as the distance between the ETF's bid/ask prices and a new measure of intraday intrinsic value constructed with the ETF's daily holdings. The two-sided measure shows that order imbalances increase trading costs in the direction of the imbalance, bias midpoint quotes, and result in observed premiums and discounts. It also provides a link between these higher trading costs and the need for authorized participants to pass through the costs associated with primary market activity.