A Tale of Two Prices: Study of Relationship Between Underlying Shares and American Depository Receipts Issued by Firms of Indian Origin

Abstract

A growing number of companies from emerging economies are cross listing their shares on international exchanges in their effort to access the developed stock markets. The purpose of this paper is to look into the trends in prices of each dually listed stock that is being traded on the American and Indian stock exchanges. By taking the data for the period of five calendar years (January 2009 to December 2013) the annual absolute returns given by the ADRs and underlying equity shares of eight Indian companies, who have listed their ADRs on New York Stock Exchange (NYSE) are calculated and compared. The relationship between daily closing prices of underlying stocks and daily closing prices of ADRs is studied by using Carl Pearson‘s correlation coefficient. The relationship between daily closing prices of ADRs on NYSE and daily closing prices of underlying equity stocks on NSE during the study period five years is strong positive, implying that American Depository Receipts derive its price from price of its underlying shares and movement in ADR prices strongly follows the movement in prices of underlying shares.. The associated premia levels of each stock on the American Stock Exchange along with the movements of the underlying stock in the Indian stock market have been studied. ADRs of Infosys, Tata Motors, Dr. Reddy‘s Lab and ICICI traded at very thin premium level implying absence of arbitrage opportunities between ADRs and underlying stocks. ADRs of HDFC, MTNL and Sesa Sterlite traded at discount of 78.08, 0.96 and 37.64 per cent respectively implying the incentive for the ADR holders in USA to cancel ADRs, convert them into underlying shares and make arbitrage profit by selling the underlying shares in India. There is no significant difference between average stock returns and average ADR returns given by selected companies during the study period of five years

Keywords: American Depository Receipt, Underlying Shares, Cross Listing, ADR Premium

JEL Classification: G19