Returns on Adrs and Arbitrage in Emerging Markets

33 Pages Posted: 31 Aug 2003

See all articles by Ramon Rabinovitch

Ramon Rabinovitch

University of Houston - Department of Finance

Ana Cristina Silva

Merrimack College

Raul Susmel

University of Houston - Department of Finance

Date Written: April 2003

Abstract

In this paper we compare the distributions of ADR returns and the returns of the locally traded shares between Chile and Argentina. This comparison is interesting because both countries are emerging economies with a similar free market orientation and the trading hours in both countries virtually coincide with the trading hours in New York. Argentina and Chile differ, however, in two important aspects: During our sample period, (1) The Argentinean market was completely under a fixed-exchange rate system, while Chile maintained a flexible exchange rate regime and (2) Argentina did not impose any restrictions on foreign investments, while Chile did. We find that the return distributions of the Chilean ADRs are significantly different from the distributions of the returns on the respective underlying Chilean shares. While the mean returns are the same, the return's standard deviations are significantly different. In contrast, the hypothesis that the distributions of the returns on the Argentinean ADRs and the returns on their respective underlying shares are the same cannot be rejected. We then use a threshold model to estimate the transaction costs of trading the ADRs and the locally traded shares. We find that the transaction costs that must be added to the returns spread before arbitrage is possible were between 100 and 200 basis points for Chilean ADRs. It was between 66 to 165 basis points for the Argentinean ADRs. The daily return spread reversion caused by arbitrage activities was estimated to be around 30% for Chilean ADRs and 40% for Argentinean ADRs. Finally, we cannot reject the hypothesis that low liquidity was a major factor in the cost difference between the two countries.

Keywords: Emerging Markets, Arbitrage, Threshold AR Models

JEL Classification: F3, G1

Suggested Citation

Rabinovitch, Ramon and Silva, Ana Cristina and Susmel, Raul, Returns on Adrs and Arbitrage in Emerging Markets (April 2003). Available at SSRN: https://ssrn.com/abstract=405900 or http://dx.doi.org/10.2139/ssrn.405900

Ramon Rabinovitch

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4782 (Phone)

Ana Cristina Silva

Merrimack College ( email )

North Andover, MA 01845
United States

Raul Susmel (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4763 (Phone)
713-743-4789 (Fax)