Liquidity, Volatility, and ETF Arbitrage in Canadian Equity Markets Evidence from Stress Episodes

This paper examines the interaction between market liquidity, volatility, and exchange-traded fund (ETF) arbitrage activity in Canadian equity markets, with a particular focus on periods of financial stress. Using high-frequency and daily market data, the study analyzes how deviations between ETF prices and their net asset values (NAVs) evolve under heightened volatility and constrained liquidity conditions. The empirical framework exploits stress episodes characterized by sharp volatility spikes and funding frictions to identify changes in arbitrage intensity and price efficiency. Results indicate that during stress periods, liquidity deterioration and elevated volatility significantly widen ETF price–NAV deviations, reflecting limits to arbitrage faced by authorized participants. These effects are more pronounced in equity ETFs with less liquid underlying assets. The findings highlight the role of ETFs as both liquidity providers and transmitters of market stress, with important implications for market resilience and regulatory oversight in concentrated equity markets such as Canada.