A tale of two prices: Liquidity and asset prices in multiple markets

Abstract

This paper investigates the liquidity effect in asset pricing by studying the liquiditypremium relationship of an American Depositary Receipt (ADR) and its underlying share.Using the Amihud (2002) measure, the turnover ratio and trading infrequency as proxies for liquidity, we show that a higher ADR premium is associated with higher ADR liquidity and lower home share liquidity, in terms of changes in these variables. We find that the liquidity effects remain strong after we control for firm size and a number of country characteristics, such as the expected change in the foreign exchange rate, the stock market performance, as well as several variables measuring the openness and transparency of the home market.JEL Classification: G10, G12, G15

The Role of Liquidity in ADR Mispricing: Evidence from Latin America

“…Chan et al (2008b) find that the impact of liquidity on price differentials in closed end country funds is -exacerbated in segmented markets, and according to Hunter (2006), Latin American markets are segmented and exhibit no trend toward greater integration with the U.S. market. In light of these findings, the results in Chan et al (2008a) may not reflect the true impact of liquidity on price deviations between ADRs and their corresponding Latin American stocks.…”

“…Chan et al (2008a) and Grossman et al (2007) use a variation of this measure to capture ADR mispricing on a monthly basis. In both, the deviation is expressed as the difference between the ADR and the price of the underlying stock relative to the price of the underlying stock with no natural logarithms employed.…”

“…In some cases, ADRs and/or their underlying stocks are so illiquid that there is no trading of the stocks for many regular trading days in any given quarter. Following Chan et al (2008a), ADR Infrequency is the percentage of U.S. trading days in a given quarter that the ADR is not traded. Chan et al (2008a) Argentina, four from Brazil, and four from Chile) are excluded because they typically operate in heavily regulated environments.…”

“…Following Chan et al (2008a), ADR Infrequency is the percentage of U.S. trading days in a given quarter that the ADR is not traded. Chan et al (2008a) Argentina, four from Brazil, and four from Chile) are excluded because they typically operate in heavily regulated environments. Stocks with missing and/or distorted price or volume data are also excluded.…”

“…Of particular importance to this study are the findings of Chan et al (2008a), which report the impact of liquidity on the price deviations between ADRs and their underlying stocks. They find that higher ADR liquidity is associated with a higher ADR premium but find little support to indicate that changes in the liquidity of the underlying stock affect the ADR premium.…”