This paper investigates the performance and trading characteristics of 43 German Exchange Traded Funds (ETFs) traded on XTRA market during the period 2003-05. The findings show that these ETFs perform similar to the underlying indexes but are riskier than indexes. German ETFs do not adopt full replication strategies, a fact that results in a substantial tracking error. Return is positively related to risk and negatively related to tracking error. Furthermore, the volatility of German ETF returns is found to be positively correlated to tracking error, premium and intraday volatility, which means that the higher the magnitude of these variables, the higher the risk of ETFs. On the other hand, the risk of investing in German ETFs is negatively related to bid-ask spread. Tracking error is positively related to risk, premium and spread, while the expense ratio decreases when the size of ETFs increases due to economies of scale. Going further, the magnitude of bid-ask spread and the corresponding cost of investing in German ETFs increase when the premium and intraday volatility increase too. Finally, turnover is negatively related to intraday volatility.

Exchange Traded Funds (ETFs) are investment vehicles which are aimed at replicating the performance and risk of specific broad market, sector and international equity and fixed-income indexes as well as commodities. They combine the features of mutual funds as they are baskets of shares, and ordinary stocks as they trade throughout the trading day on stock exchanges.

Given their popularity, ETFs have attracted the interest of practitioners, academics and researchers. In an earlier study, Gastineau (2001) described the main types of ETFs and analyzed their origins, characteristics and the operating mechanism. Elton, Gruber, Comer and Li (2002) studied the performance of SPDRS, which was the first ETF to be launched in the US stock market and tracked the S&P 500 index. The authors found that the performance of this ETF is inferior to the return of the underlying index as well as the corresponding index funds and future contracts. The underperformance of SPDRS is attributed to the policy of SPDRS as Unit Investments Trusts to keep the dividends it receives on the underlying stocks in non-interest generating bank accounts.

In another study on SPDRS, Poterba and Shoven (2002) examined its performance at the before-tax and after-tax level and compared it with the respective performance of the Vanguard 500 index fund, which is the largest fund investing in the equities of the S&P 500 index. The study showed that both these investment vehicles display a similar behavior, i.e., they perform similarly.

Going further, Jares and Lavin (2004) turned their attention to Japan and Hong Kong iShares which trade on the US stock market. Their investigation is concerned with the correlation between the trading prices and the net asset values of these ETFs. The researchers found substantial differences between these values and concluded that the time differences between the US market, on which these ETFs trade, and the local markets, where the equities comprising the relevant tracking indexes trade, are the main factors that can explain the premiums/discounts in the trading prices of these Asian ETFs.

Applied Finance Journal, German, Exchange, Traded, Funds, ETFs, XTRA, SPDRS, Asian ETFs.