Short Selling and Price Discovery: Evidence from American Depositary Receipts

Abstract

The underlying shares of some American Depositary Receipts (ADRs) can be short sold in their home markets while 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. We find that the top quintile portfolio of heavily shorted ADRs significantly outperforms the bottom quintile by over 2.6% per month when the ADRs’ underlying shares cannot be short sold in the home market. In contrast, there are small and less significant differences between the top and bottom quintile returns when the ADRs’ underlying shares can be short sold in the home market. These and related results suggest that short sellers make a significant contribution to the price discovery process. Short sellers’ trading activity, representing over 20% of total ADR share volume, increases the benefits of cross-listing on U.S. exchanges.

Keywords: American Depositary Receipts (ADRs), Short Sales, Price Discovery

JEL Classification: G12, G14, G15