Do ETFs Follow Liquidity or Create It? Evidence from the Korean Market

This study examines the causal relationship between exchange-traded fund (ETF) ownership and stock liquidity in the Korean equity market. Using a panel dataset of firms listed on the KOSPI and KOSDAQ, we analyze the effect of ETF ownership on several liquidity measures, including the Amihud illiquidity measure, Lesmond transaction cost measure, and high-low spread. The results indicate that increases in ETF ownership significantly improve stock liquidity even after controlling for firm characteristics and fixed effects. We further test for potential reverse causality—whether stock liquidity attracts ETF ownership—and find only limited evidence supporting this channel. Both the magnitude and statistical significance of the reverse effect are substantially weaker than those of the direct impact of ETF ownership on liquidity. Overall, these findings suggest that ETFs are not merely passive investors but play an active role in enhancing stock market liquidity. This study provides new evidence on the relationship between ETF ownership and stock liquidity in the Korean market and highlights the implications of ETF growth for market microstructure.