Impact of Financial Crisis on International Price Discovery: Evidence from Indian American Depository Receipts

By Inani, Sarveshwar Kumar | South Asian Journal of Management, January-March 2016 | Go to article overview

Impact of Financial Crisis on International Price Discovery: Evidence from Indian American Depository Receipts


Inani, Sarveshwar Kumar, South Asian Journal of Management


(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

American Depository Receipts (ADRs) were introduced by J P Morgan in the year 1927. The main purpose of ADRs was to introduce a way for international diversification to the investors of the United States of America (US). ADR is a security traded in dollars and it is equivalent to a certain number of shares in a non-US company. ADRs are traded in the US market as US securities and have all features held by ordinary shares of US companies. Depository Receipts (DRs) have various advantages for issuing company such as reduction in the cost of capital, presence in the international market, broadening international equity market, etc. DRs could be listed on primary stock exchanges of the world such as NYSE, NASDAQ, or Luxembourg Stock Exchange. Global investors invest in depository receipts for various reasons, but the main purpose is international diversification. There are some restrictions on investors for direct investment in the equity of a foreign company, but depository receipts are traded as domestic securities, so investors can easily diversify their portfolio in the equity of foreign firms. Depository receipts are preferred to direct investment in foreign equity as trading in depository receipts is convenient and cost effective. All Indian ADRs in this study are sponsored and level III (except Tata Motors, which is level II ADR). There are three levels of ADRs being traded in US markets, based on compliance with norms of US Securities Exchange Act of 1934. Level I ADRs trade in Over-The - Counter (OTC) markets, level II ADRs are listed on an Exchange in the US, and level III ADRs can raise money through IPO in US markets.

Under the limited two-way fungibility scheme, the conversion of shares into ADRs is limited up to certain threshold limit fixed by guidelines. The most important point to be noted is that only non-residents or Foreign Institutional Investors (FIIs) can participate in the trading of these instruments, but retail Indian investors are not allowed to participate in the trading of ADRs. Several Non-Resident Indians (NRIs), hedge funds, FIIs and domestic arbitrage funds are very active in this market. The study of ADRs seems to be an important component of examining international equity market integration.

ADRs offer a unique medium to analyze the transmission of information between the countries as they are transacted in the US but denote ownership of underlying foreign securities. India and the USA are having no overlapping of trading hours. The total trading time for a security having ADR is 13 hours a day out of entire 24-hours. US time zone is GMT-5:00 hours and India's time zone is GMT + 5:30 hours. Due to asynchronous trade timings, a study with intraday data is not possible on Indian ADRs. Typical trading schedules of NSE and NYSE/NASDAQ can be shown in Table 1 below:

As of February 2014, India has issued 371 depository receipts, but some of them are terminated. As per the latest information available on adr.com, a site maintained by JP Morgan, a total number of depository receipts is 294, out of which fourteen are ADRs and rest are Global Depository Receipts (GDRs). India has issued the highest number of GDRs. India has preferred GDRs as compared to ADRs in raising capital due to flexible norms of GDR markets. Every depository receipt represents a certain number of underlying shares which is called depository ratio. Like the ADR of HDFC Bank Ltd. has a ratio of 1:3 that implies that three shares in the domestic market are equivalent to one ADR listed in the US market.

The rest of the paper is structured as follows. Existing literature have been described in Section 2. Section 3 summarizes data and descriptive statistics of prices of ADRs and corresponding underlying shares. Section 4 contains methodology. Section 5 presents empirical results and findings. Section 6 expresses conclusion. Finally, Section 7 discusses the limitations of the study and scope for further research. …

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