The ADR shadow exchange rate as an early warning indicator for currency crises

We develop an indicator for currency crisis risk using price spreads between American Depositary Receipts (ADRs) and their underlyings. This risk measure represents the mean exchange rate ADR investors expect after a potential currency crisis or realignment. It makes crisis prediction possible on a daily basis as depreciation expectations are reflected in ADR market prices. Using daily data, we analyze the impact of several risk drivers related to standard currency crisis theories and find that ADR investors perceive higher currency crisis risk when export commodity prices fall, trading partners’ currencies depreciate, sovereign yield spreads increase, or interest rate spreads widen.     

Contemporaneous ADR pricing: intraday dynamics during overlapping trading hours

We contribute to the literature by identifying and accurately measuring the drivers of American depositary receipt (ADR) returns contemporaneously across various global time zones. We consider ADRs as two inherently distinct asset classes – stocks and currencies – bundled into one. Throughout, we use a relatively refined, focused, and synchronized minute-by-minute data set on ADRs and all other variables. ADRs from all countries with regular trading hours that overlap with those of the US are considered individually and in clusters. We analyze the interplay of several factors that influence ADRs pricing patterns. Further, we investigate whether such patterns vary by currency, ADR, industry, and emerging/developed market classifications. Our findings indicate that synchronized returns on underlying shares comprise 68.5–74% of the explained returns in ADRs. The remaining 31.5–26% of returns are generated by movements in currency rates. These results are robust across the several models and estimation methods employed. Our findings also show persistent small price discrepancies between ADRs and dollar-adjusted underlying shares on a minute-by-minute basis, implying possible arbitrage opportunities. However, we conclude that trading and ADR conversion costs render such opportunities unattractive.     

Price discovery and the international flow of information

We document that the opening volatility of American depositary receipts (ADRs) is lower when the trading of the underlying asset overlaps trading of the ADR on the New York Stock Exchange (NYSE). This lower volatility is consistent with the notion that price discovery on the NYSE is enhanced by concurrent trading in the underlying market. We also find that ADR volatility does not change when the underlying market closes, indicating that there is no significant change in the flow of public and private information at that time. This finding suggests that the NYSE becomes the dominant market during periods when both ADRs and their underlying assets are traded.     

Determinants of returns and volatility of Chinese ADRs at NYSE

This paper examines the determinants of returns and of volatility of the Chinese ADRs as listed at NYSE. Using an autoregressive conditional heteroskedasticity (ARCH) model and data from 16 April 1998 through 30 September 2004, we find that Hong Kong stock market (underlying market), US stock market (host market), and local (Shanghai A and B) markets all are important determinants of returns of the Chinese ADRs. However, the underlying Hong Kong market has the most significant impact on mean returns of the ADRs. In terms of the determinants of the conditional volatility of the ADRs returns, only shocks to the underlying markets are significant. These results are consistent with [Kim, M., Szakmary, A.C., Mathur, I., 2000. Price transmission dynamics between ADRs and their underlying foreign securities. Journal of Banking and Finance 24, 1359–1382] who find that the most influential factor in pricing the ADRs in Japan, UK, Sweden, The Netherlands and Australia is their underlying shares. Implications of the results for investors are discussed.     

The dynamics of volatility transmission and information flow between ADRs and their underlying stocks

This research examines the dynamics of volatility transmission and information flow between ADRs and the underlying stocks. Using a bivariate GARCH model with BEKK parameterisation, the study investigates how changes in volatility in the ADR market affect the volatility in the underlying equity market and vice versa. The findings suggest a bidirectional volatility transmission and information flow between the ADR and underlying stock markets. ADRs and underlying stocks respond to their own innovations as well as to the innovations in each other's market. The findings are consistent for all countries in the sample as well as for different sub-periods. The evidence suggests that the differences in synchronicity of trading period between the US market and other developed markets included in the sample has had no effect on the volatility transmission and information flow between ADRs and underlying stocks.     

ADR holdings of US-based emerging market funds

What motivates investors to hold American Depositary Receipts (ADRs) rather than the underlying stock of US listed foreign firms? We analyze the investment allocation decision of actively-managed emerging market mutual fund managers. Although legal provisions are typically assumed to affect ADR and its underlying domestic shares equally, investors holding ADRs may have a higher level of legal protection as these securities are issued and traded in the US. We find that ADRs are the preferred mode of holdings if the local market of the issuer has weak investor protection, low liquidity and high transaction costs.     

SHORT SELLING AND PRICE DISCOVERY: EVIDENCE FROM AMERICAN DEPOSITARY RECEIPTS

The underlying shares of some American Depositary Receipts (ADRs) can be short sold in their home markets, and others cannot. This institutional feature offers a unique opportunity to investigate the relation between short selling and price discovery. We hypothesize and confirm that ADR short selling on a U.S. exchange is more informative when the ADRs’ underlying shares cannot be short sold in the home market. These and related results suggest that short sellers make a significant contribution to price discovery. Short sellers’ trading activity, representing more than 20% of total ADR share volume, increases the benefits of cross‐listing on U.S. exchanges.     

Theory and evidence on the dynamic interactions between sovereign credit default swaps and currency options

Using sovereign CDS spreads and currency option data for Mexico and Brazil, we document that CDS spreads covary with both the currency option implied volatility and the slope of the implied volatility curve in moneyness. We propose a joint valuation framework, in which currency return variance and sovereign default intensity follow a bivariate diffusion with contemporaneous correlation. Estimation shows that default intensity is much more persistent than currency return variance. The market price estimates on the two risk factors also explain the well-documented evidence that historical average default probabilities are lower than those implied from credit spreads.     

Lost in translation: Delayed ex-dividend price adjustments of Hong Kong ADRs

Previous research documents that Hong Kong stocks have a full ex-dividend price adjustment consistent with dividends and capital gains being tax free. We examine ex-dividend price behavior of Hong Kong ADRs to assess the impact of differing tax environments in US and Hong Kong. These ADRs typically go ex-dividend before their underlying stock. They experience significant abnormal returns of 1.16% on their ex-day; the average ex-day price drop is only 30% of the dividend. However, ADR prices drop when the underlying stock goes ex-dividend subsequently. The cumulative ADR price drop is equal to the dividend. Thus, the ADR ex-dividend adjustment resembles that of the underlying stock, consistent with home country tax laws governing ADR price behavior. Neither liquidity nor transaction costs can explain the anomalous delayed ex-dividend adjustment of ADRs.     

DO FOREIGN INVESTORS PRICE FOREIGN EXCHANGE RISK DIFFERENTLY?

We test whether foreign investors price foreign exchange risk differently from local investors. Drawing from the closed‐end country fund literature, we argue that both differential access to information by foreign versus local investors and different sources of exchange risk that investors face (economic or translation exposure) will lead to different pricing of the exchange risk associated with American Depositary Receipt (ADR) investments. We apply a two‐step method to country portfolios of ADRs of Australia, France, Japan, and the United Kingdom traded on the New York Stock Exchange. Our results show that foreign investors generally price exchange risk differently from local investors, and that the source and magnitude of differences in exchange risk pricing vary significantly across countries. Although significant differences in pricing exchange risk between foreign and local investors are observed for Australia, France, and Japan, no such pricing difference is noticed for the United Kingdom. Furthermore, the pricing differences observed for Australian and French ADRs are mainly attributed to the exchange risk of underlying share returns (economic exposure), whereas the pricing differences for Japanese ADRs are mainly attributed to the exchange risk associated with currency translation (translation exposure). We offer some explanations for our findings.     

What do investment banks charge to underwrite American Depositary Receipts?

We investigate how investment banks determine the gross spreads paid by American Depositary Receipts (ADRs) from 1980 to 2004. We begin by comparing the gross spreads of ADR IPOs and ADR SEOs to those of matching US IPOs and US SEOs. We document clustering at the 7% level for our ADR IPO sample (44% for the ADR IPO firms without a previous equity listing), whereas our ADR SEO sample exhibits no discernable clustering at any level. We then find that ADR IPO gross spreads can be explained by firm and offer characteristics (similar to our matched sample of US IPOs), and by whether the ADR IPO firm has a previous equity listing. ADR SEO gross spreads can be explained more by offer characteristics (more similar to our matched sample of US SEOs).     

Taxes,International Clienteles and the Value of ADR Dividends

An alternative approach to valuing dividends is developed and applied to American Depositary Receipts (ADRs) on Australian stocks. The values of ADR dividends are estimated from the period when, due to different ex‐dividend dates, the ADRs and their underlying stocks trade with differential dividend entitlements. Australian ADR dividends are valued at less than their face value and the dividends on the underlying stocks are valued at more than their face value. This suggests that ADR dividends are priced by a clientele of US investors placing little value on the imputation tax credits attached to the dividends and that a clientele of Australian resident investors, who obtain value from imputation tax credits, price the dividends on the underlying stock.     

Impact of exchange rate movements on exports: An analysis of Indian non-financial sector firms

We explore the real effective exchange rate (REER) effects on the share of exports of Indian non-financial sector firms for the period 2000–2010. Our empirical analysis reveals that, on average, there has been a strong and significant negative impact from currency appreciation and currency volatility on Indian firms' export shares. Labor costs are found to intensify the exchange rate effects on trade. Further, there is evidence that the Indian firms considered here respond asymmetrically to exchange rates. For instance, the REER change effect is more likely to be driven by a negative appreciation effect than a depreciation effect. Also, Indian firms that have smaller export shares tend to have a stronger response to both REER change and volatility. Compared with those exporting goods, firms that export services are more affected by exchange rate fluctuations. The findings, especially those on asymmetric responses, have important policy implications.     

The effect of interest rate volatility and equity volatility on corporate bond yield spreads: A comparison of noncallables and callables

This research investigates the impact of interest rate volatility upon corporate bond yield spreads. We first consider the impact of interest rate volatility upon noncallable bond spreads. Because greater interest rate volatility likely increases the volatility of the firm's debt, we hypothesize that the relation will be positive. Given that we do find a positive relation, we thus investigate whether the positive effect of interest rate volatility on yield spreads is stronger or weaker for callable bonds. We find that the effect is weaker for callable bonds. This result indicates that there is a negative relation between default spreads and call spreads, which is consistent with the theory of Acharya and Carpenter (2002), but in contrast to the theory of King (2002). Furthermore, our results for the relationship between equity volatility and yield spread tend to support Acharya and Carpenter (2002) more than King (2002).     

Central bank intervention and the intraday process of price formation in the currency markets

We propose a novel theory of the impact of sterilized spot interventions on the microstructure of currency markets that focuses on their liquidity. We analyze the effectiveness of intervention operations in a model of sequential trading in which i) a rational Central Bank faces a trade-off between policy motives and wealth maximization; ii) currency dealers' sole objective is to provide immediacy at a cost while maintaining a driftless expected foreign currency position; and iii) adverse selection, inventory, signaling, and portfolio balance considerations are absent by assumption. In this setting, and consistent with available empirical evidence, we find that i) the mere likelihood of a future intervention—even if expected, non-secret, and uninformative—is sufficient to generate endogenous effects on exchange rate levels, to increase exchange rate volatility, and to impact bid-ask spreads; and ii) these effects are exacerbated by the intensity of dealership competition, the extent of the Central Bank's policy trade-off, and the credibility of its threat of future actions.     

Disruption and stock markets: Evidence from Hong Kong

We examine the impact of disruption on stock markets using the 2019 Hong Kong protests for identification. We find that greater protest intensity corresponds to higher bid–ask spreads, lower trading volume, and greater return volatility for dual-listed Chinese firms’ Hong Kong (H) shares but not their home (A) shares. We also document negative abnormal returns only for these firms’ H-shares around major protest events, which shortly after exhibit reversal. Next, we validate our main findings by documenting similar results using Hong Kong-listed firms only. Overall, we provide new evidence highlighting the impact of protest-induced disruption on financial markets.     

Underpricing and aftermarket performance of American depositary receipts (ADR) IPOs

American depositary receipts (ADRs) are negotiable instruments representing foreign company shares traded in US dollars in the US capital market. We present comparative analyses of the pricing and aftermarket performance of Initial Public Offerings (IPOs) by ADRs and a matching sample of US firms over the 1990–2001 period. Offered by large, well-known multinationals, ADR IPOs go through a detailed scrutiny, and incur significant costs, during the pre-IPO period to recast financial statements in conformity with SEC rules and the US GAAP. This mitigates the information asymmetry between the IPO firm and investors. We categorize the ADR issuing country as developed or emerging, and our sample includes several cases of privatization of state owned corporations. The analyses indicate that (1) ADR IPOs are significantly less underpriced than comparable US IPOs; (2) IPOs from developed countries are more underpriced; and (3) Privatization IPOs are less underpriced than non-privatizations. The lower underpricing of ADR IPOs persists even after differential IPO attributes, the traditional proxies for information asymmetry and, the unique characteristics associated with ADR IPOs, are accounted for. We conclude that extant literature offers only partial explanation for this puzzling phenomenon.     

Exchange rate expectations and the pricing of Chinese cross-listed stocks

I show that the price discounts of Chinese cross-listed stocks (American Depositary Receipts (ADRs) and H-shares) to their underlying A-shares indicate the expected yuan/US dollar exchange rate. The forecasting models reveal that ADR and H-share discounts predict exchange rate changes more accurately than the random walk and forward exchange rates, particularly at long forecast horizons. Using panel estimations, I find that ADR and H-share investors form their exchange rate expectations according to standard exchange rate theories such as the Harrod-Balassa-Samuelson effect, the risk of competitive devaluations, relative purchasing power parity, uncovered interest rate parity, and the risk of currency crisis.     

Return behavior and pricing of American depositary receipts

This paper provides an empirical analysis of 123 American depositary receipts (ADRs) from 16 countries. The paper finds that the returns on ADRs have significant risk exposures to the returns on the world market portfolio and their respective home market portfolios. Further, ADRs do not have significant risk exposures to changes in their home currency’s exchange rates. In explaining variations in ADR returns, a multi-factor model with the world market return and the home market return as the risk factors performs better than models with just the world market return, the home market return or a set of global factors as the risk factors.     

Day and night returns of Chinese ADRs

Are the returns of Chinese American Depositary Receipts (ADR) more affected by the US market or their underlying home market? We separate Chinese ADR daily returns into day and night returns to investigate the different market effects on ADR pricing. We compare “homeless” ADRs to home-based or cross-listed ADRs to see if they are affected differently by market factors. We find the night returns of Chinese ADRs are significantly affected by their home market (either the Hong Kong market or mainland China market) daily returns and the US market night returns. The US day returns appear to be the most significant pricing factor for the day returns of Chinese ADRs. The homeless ADRs are more affected by the US market and less affected by their home market compared to the cross-listed ADRs.