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Rakesh Gupta: Linkages between the ADR market and home country macroeconomic fundamentals: Evidence in the context of the BRICs


By Rakesh Gupta, Tian Yuan and Eduardo Roca    Source: International Review of Financial Analysis




This study investigates the long-run and short-run lead–lag linkages between American Depositary Receipt (ADR) prices and home country economic fundamentals in the context of the BRICs (Brazil, Russia, India and China). In order to obtain an indication of the segmentation or integration between the ADR market and its underlying stock market, the same investigation is also undertaken in relation to the latter. We find that in the long run, economic growth positively drives ADR returns in the cases of Brazil and China but negatively in the cases of Russia and India. In the short-run, economic growth and money supply lead ADR prices but ADR prices predict inflation and oil prices with regard to Brazil while in Russia, oil prices predict ADR returns but the ADR market leads monetary policies and real economic activity. As regards India, in the short run, oil prices and economic growth lead ADR prices but ADR prices predict money supply changes. Finally, with respect to China, the ADR index lead economic growth and inflation but economic variables do not predict ADR prices in the short-run. In the long run, with the exception of China, we find the same kind of linkages between these economic fundamentals and the underlying stock market although the linkages are somewhat stronger. The short run dynamics for ADRs with respect to economic fundamentals are, however, different for that of the respective home country stock market. This would imply that the ADR market and its underlying stock market, as far as the BRICs are concerned, are integrated in the long-run but not in the short-run.



The Securities and Exchange Commission (SEC) defines an American Depositary Receipt (ADR) as a ‘negotiable instrument that represents an ownership interest in a specified number of securities, which the secu-rities holders have deposited with a designated bank depository.’ ADR programs have substantially increased since the 1990s. There were 836 ADR programs in 1990, which grew to 1534 in 2000. This can be attributed to the global boom in technology and the acceleration in mergers and acquisitions (Patro, 2000).

In recent years, emerging markets have accounted for a growing per-centage of total ADR offerings, owing to the opening up of these markets to international investors. According to the New York Bank, 52 billion ADRs valued at USD $2.07 trillion were traded during the first half of 2008. China, Brazil and Russia collectively accounted for over 50% of the total trading value. India led the new sponsored ADRs, with 11 new programs in 2008. During the post-2008 crisis period, issuers from the four BRICs nations (Brazil, Russia, India and China) seem to continue to dominate the ADR market. As suggested by Reyes (2013) in terms of number of programs, the top four countries are from the BRICs nations, representing 35% of the depositary receipt (DR) universe.

The ADR market statistics suggest a strong demand from the US investors for foreign shares from emerging markets, particularly from the four BRICs nations. Such an investment trend seems to be in line with the conventional view that ‘higher growth means higher returns’. The logic behind this is that corporate earnings are expected to portray the overall economic trend in the long run. Dividends paid by the corporate therefore should grow at a similar rate to the overall economy. As such, rapidly growing economies will yield high growth rates of dividends and hence high stock returns. Intuitively, these investors are positive about the outlook for these emerging economies. They invest in ADRs from these countries, hoping to obtain superior stock returns.

An implied assumption is that the ADR markets correctly reflect the economic trends of the underlying nations and also the future performance of the corporations issuing the ADRs. This appears to be a fair argument, in that ADRs are derivatives which derive their value from the performance of their underlying stocks. Hence, the ADR market can be viewed as being a fraction of the home country stock market. In efficient and frictionless markets, redundant assets can be priced according to the law of one price (see Kato, Linn, and Schallheim (1991)). As such, if the markets are efficient and integrated and frictionless, the transmission mechanism between ADRs and the economic fundamentals should be similar to that for the underlying stock market.


However, in practice, ADRs may be different from their underlying stocks. For example, to list ADRs on the US market, the non-US issuing firms must comply with all the requirements of the SEC. Such rigorous regulation will lead to higher transparency in the ADR market and hence lower risks for investment in ADRs compared with the foreign eq-uity markets. In addition, the heterogeneity of risk perceptions between US investors and local investors in the underlying foreign stock markets may also contribute to divergence between ADRs and their stocks. More importantly, the economic exposure for ADRs may be different to that of its national stock market index. This is because ADRs are cross-border listed securities; the impact of local economic factors on ADRs will be affected by the extent to which the international markets are informationally efficient and integrated with each other. Due to the above reasons, there may not be a clear correspondence between the eco-nomic fundamentals of the respective home market and ADR performance.

The interrelationship of the equity market and the real economy has been extensively investigated by empirical researchers. In general, these studies examine the causal relationship between the national stock market index and selected macroeconomic variables. However, there has been little interest in the context of this relationship in the ADR markets. The existing ADR literature mainly focuses on two aspects. One group of empirical studies examines the effectiveness of ADRs as a diversification vehicle. These papers generally compare the diversification benefits gained from investing in ADRs with those from their underlying stock, home market index, or alternative investment vehicles (e.g. mutual funds and multinational corporations). Another group of studies focuses on the issues that relate to the ADR pricing. In particular, extensive research has been conducted in order to gain an understanding of the law of one price in the ADR markets. Hence, due to the lack of studies on this issue, there is no clarity yet as regards the linkage between home country economic variables and ADR prices and the extent to which this linkage is similar in relation to the home country stock market.

In this paper, we address this gap in the literature. We examine the linkage between home country economic fundamentals and ADR prices. Specifically, we investigate whether there is a long run relationship be-tween the major home country economic indicators and ADR prices. We also examine the short-run lead–lag relationship between ADR prices and the home country`s economic indicators. There are two views re-garding the lead–lag relationship between stock returns and macroeconomic variables. One argument claims that the causality runs from the macro environment to financial markets, since economic growth leads to better stock market performance. The alternative argument asserts that if stock returns accurately reflect the expectation about underlying fundamentals in the future, then they should be used as leading indicators of future economic activities. The second objective of the study would enable us to determine whether the economic status of the coun-try is a predictor of its corresponding ADR market in the short run, or vice versa. Finally, we also investigate whether this linkage is in line with that of its underlying stock market in order to obtain an indication of the segmentation or integration between the two markets.

This study focuses on the BRICs nations` ADR markets. The four emerging economies are in transition towards becoming more market-oriented economies. As such, these four countries provide a good experimental basis from which to identify whether changes in macroeconomic conditions in these nations will lead to changes in ADR prices. The findings of this study will have important implications for the policy makers in the BRICs nations in their quest towards devel-oping a more attractive environment for investment. Given the growing significant role of the BRICs countries in investors` portfolio strategy, the findings about ADRs` interrelationship with the domestic macroeco-nomic conditions will also be of interest to US investors seeking superior returns in the BRICs nations` stock markets. To the best of the author`s knowledge, this study is the first to thoroughly examine the interrela-tionship between cross-border listed ADRs and home country economic fundamentals.

This study essentially tests the relationship of both the ADR market and its underlying stock market with four home country economic variables: industrial production index, inflation and money supply4 and oil prices. The sample period starts from January 2000 and ends in February 2013. The long-run analysis is based on the Johansen cointegration test while the examination of the short run lead–lag dynamics is undertaken using granger causality tests.

We found that ADR prices have a significant long run relationship with the economic indicators of the home country, although different characteristics are observed across the four BRICs nations. The evidence for the short run dynamics suggests that, with the exception of China, past values of these economic indicators can be used to forecast ADR prices. Investors may be able to exploit excess returns on ADRs based on the corresponding macro-level information. In general, the short run dynamics for the case of ADRs are different from that for the stock market index. This sheds some light on the informational efficiency of the ADR market regarding macroeconomic information transmission. The evidence suggests that the market efficiency of the ADR market within the BRICs countries is at least somewhat different from that of the underlying stock market.

The rest of this study is organized as follows. Section 2 reviews related studies in the literature. Section 3 discusses hypotheses, followed by Section 4 where the data are described. Section 5 demonstrates the methodology used in this research while Section 6 discusses the empirical results, and finally Section 7 concludes.


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The author Rakesh Gupta is a Visiting fellow at Chongyang Institute for Financial Studies, Renmin University of China.




Key Words: BRICs   America   market  

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