Skip to main content
SpringerLink
Log in

Liquidity and price discovery in Latin America: evidence from American depositary receipts

  • ARTICLES
  • Published:
Journal of Economics and Finance Aims and scope Submit manuscript

Abstract

This study provides a comprehensive examination of price discovery for American Depositary Receipts (ADRs) originating in Latin America. Using data on 87 ADR issues from Latin America, the empirical approach allows for an endogenous role of exchange rate fluctuations in the price discovery process. The results indicate that while exchange rates are not primarily determined by stock market prices, there is significant flow of information from the stock market to currency markets particularly in Brazil and Mexico. In addition, the results reveal a mix of price discovery locations across Latin America. The conventional finding that the home market matters most for price discovery holds only for Chile. For ADRs from Brazil, the home and U.S. markets contribute equally to price discovery while the U.S. market dominates in price discovery for ADRs from Argentina and Mexico. Results from a cross-sectional analysis indicate that higher levels of illiquidity at home are consistent with higher contributions to price discovery from the U.S. market.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. To the author’s knowledge, only von Furstenberg and Tabora (2004) examine the question of price discovery in Latin America. Their sample consists of 2 cross-listed firms from Mexico.

  2. An exception is Aquino and Poshakwale (2006) who document, using a panel data approach, that ADR returns are more sensitive to changes in U.S. than home market returns and that they are exposed to exchange rate risk.

  3. A complete list of ADR programs is available from the author upon request.

  4. The Amihud(2002) measure is calculated daily and averaged over the sample period. The measure is calculated as the ratio of the return to the dollar trading volume of the ADR each day, scaled by 106. The measure is similar for the corresponding underlying stock (ILLIQ H), but the daily trading volume is converted from the home currency into U.S. dollars at the corresponding exchange rate each day. This adjustment ensures that the measure is calculated on the same basis for all countries.

  5. The price is also adjusted by the conversion ratio.

  6. The impulse response functions are computed 500 steps ahead.

  7. If the conditional information share is x then the transformed variable is ln(x/1-x).

  8. Empirical results are only presented using the Amihud (2002) illiquidity measures. Results are qualitatively similar when using trading infrequency to gauge stock illiquidity. The latter results are available from the author upon request.

  9. Tests are conducted using daily data from 1/1/2003 to 12/31/2010. A deterministic trend is included only when testing the series in levels. Lag length (k) for the ADF tests is chosen by the Campbell-Perron data dependent procedure, whose method is usually superior to k chosen by the information criterion, according to Ng and Perron (1995). The Ng and Perron (2001) M-tests, MZα and MZt, can be viewed as modified versions of the Phillips and Perron (1988) Zα and Zt tests, which suffer from severe size distortions when the errors have a negative moving average (MA) root. The method involves construction of the DF-GLS modified ADF test proposed by Elliott et al. (1996) and computation of the MZα and MZt statistics as defined in Ng and Perron (2001). Lag lengths for the M-tests are selected using the modified Akaike information criteria

  10. See Johansen (1991) for a detailed description of these tests. Cointegration tests allow for a trend in the data series but not in the cointegration equation.

  11. The author thanks an anonymous referee for suggesting this line of thought. Individual firm results are available from the author upon request.

  12. The tests are conducted but not reported for various lag lengths. The text reports the results from including only one lag because only in this case is the null hypothesis rejected. Tests including other lag structures are available from the author upon request.

  13. This firm is excluded from the cross-sectional analysis due to its possible influence on the results. See Section 5.2.

References

  • Amihud Y (2002) Illiquidity and stock returns: cross section and time series effects. J Financ Mark 5:31–56

    Article  Google Scholar 

  • Aquino KP, Poshakwale S (2006) Price determinants of American Depositary Receipts (ADR): a cross-sectional analysis of panel data. Appl Financ Econ 16:1225–1237

    Article  Google Scholar 

  • Bae SC, Kwon TH, Li M (2008) Foreign exchange rate exposure and risk premium in international investments: evidence from American depositary receipts. J Multinatl Financ Manag 18:165–179

    Article  Google Scholar 

  • Baruch S, Karolyi AG, Lemmon ML (2007) Multimarket trading and liquidity: theory and evidence. J Financ 62:2169–2200

    Google Scholar 

  • Bekaert G, Harvey CR, Lundblad C (2007) Liquidity and expected returns: lessons from emerging markets. Rev Financ Stud 20:1783–1831

    Google Scholar 

  • Bin F, Morris GB, Chen D (2003) Effects of exchange-rate and interest-rate risk on ADR pricing behavior. N Am J Econ Financ 14:241–262

    Article  Google Scholar 

  • Bin F, Blenman LP, Chen D (2004) Valuation impact of currency crises: evidence from the ADR market. Int Rev Finan Anal 13:411–442

    Article  Google Scholar 

  • Chan JSP, Hong D, Subrahmanyam MG (2008) A tale of two prices: liquidity and asset prices in multiple markets. J Bank Financ 32:947–960

    Article  Google Scholar 

  • Chen S, Chou L, Yang C (2002) Price transmission effect between GDRs and their underlying stocks—evidence from Taiwan. Rev Quant Finan Acc 19:181–214

    Article  Google Scholar 

  • Chen KC, Li G, Wu L (2010) Price discovery for segmented US-Listed Chinese stocks: location or market quality? J Bus Financ Account 37:242–269

    Article  Google Scholar 

  • Choi I (2001) Unit root tests for panel data. J Int Money Financ 20:249–272

    Article  Google Scholar 

  • Choi YK, Kim D (2000) Determinants of American Depositary Receipts and their underlying stock returns: implications for international diversification. Int Rev Finan Anal 9:351–368

    Article  Google Scholar 

  • De la Torre A, Schmukler SL (2007) Emerging capital markets and globalization: the Latin American experience. Washington, DC: Stanford University Press and the World Bank

  • Diamandis PF, Drakos AA (2011) Financial liberalization, exchange rates and stock prices: exogenous shocks in four Latin American countries. J Policy Model 33:381–394

    Article  Google Scholar 

  • Elliot G, Rothenberg TJ, Stock JH (1996) Efficient tests for an autoregressive unit root. Econometrica 64:813–836

    Article  Google Scholar 

  • Ely D, Salehizadeh M (2001) American depositary receipts. An analysis of international stock price movements. Int Rev Finan Anal 10:343–363

    Article  Google Scholar 

  • Enders W (2004) Applied econometric time series. Wiley, New York

    Google Scholar 

  • Esqueda O, Jackson DO (2012) Currency depreciation effects on ADR returns: evidence from Latin America. J Econ Finance 36:691–711

    Google Scholar 

  • Eun CS, Jang H (1997) Price interactions in a sequential global market: evidence from cross-listed stocks. Eur Financ Manag 3:209–235

    Article  Google Scholar 

  • Eun CS, Sabherwal S (2003) Cross-border listings and price discovery: evidence from U.S.-listed Canadian companies. J Financ 58:549–575

    Article  Google Scholar 

  • Fang H, Loo JCH (2002) Pricing of American depositary receipts under market segmentation. Glob Finan J 12:237–252

    Article  Google Scholar 

  • Frijns B, Gilbert A, Tourani-Rad A (2010) The dynamics of price discovery for cross-listed shares: evidence from Australia and New Zealand. J Bank Financ 34:498–508

    Article  Google Scholar 

  • Garbade KD, Silber WL (1979) Dominant and satellite markets: a study of dually-traded securities. Rev Econ Stat 455–460

  • Grammig J, Melvin M, Schlag C (2005) Internationally cross-listed stock prices during overlapping trading hours: price discovery and exchange rate effects. J Empir Finan 12:139–164

    Article  Google Scholar 

  • Hacker RS, Hatemi-J A (2008) Optimal lag-length choice in stable and unstable VAR models under situations of homoscedasticity and ARCH. J Appl Stat 35:601–615

    Article  Google Scholar 

  • Halling M, Pagano M, Randl O, Zechner J (2008) Where is the market? Evidence from cross-listings in the United States. Rev Financ Stud 21:725–761

    Article  Google Scholar 

  • Harris FH, McInish TH, Shoesmith GL, Wood RA (1995) Cointegration, error correction and price discovery on informationallly linked security markets. J Financ Quant Anal 39:563–579

    Article  Google Scholar 

  • Hasbrouck J (1995) One security, many markets: determining the contributions to price discovery. J Financ 50:1175–1199

    Article  Google Scholar 

  • Im K, Pesaran H, Shin Y (2003) Testing for unit roots in heterogeneous panels. J Econ 115:53–74

    Article  Google Scholar 

  • Jiang AX (1998) Diversification with American Depositary Receipts: the dynamics and pricing factors. J Bus Finan Acc 25:683–699

    Article  Google Scholar 

  • Johansen S (1991) Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models. Econometrica 59:1551–1580

    Article  Google Scholar 

  • Kadapakkam P, Misra L, Tse Y (2003) International price discovery for emerging market stocks: evidence from Indian GDRs. Rev Quant Finan Acc 21:179–199

    Article  Google Scholar 

  • Kim M, Scakmary AC, Mathur I (2000) Price transmission dynamics between ADRs and their underlying foreign securities. J Bank Financ 24:1359–1382

    Article  Google Scholar 

  • Korczak P, Phylaktis K (2010) Related securities and price discovery: evidence from NYSE-listed Non-U.S. stocks. J Empir Financ 17:566–584

    Article  Google Scholar 

  • Lesmond DA (2005) Liquidity of emerging markets. J Financ Econ 77:411–452

    Google Scholar 

  • Liang Y, Mougoue M (1996) The pricing of foreign exchange risk: evidence from ADRs. Int Rev Econ Financ 5:377–385

    Article  Google Scholar 

  • Ng S, Perron P (1995) Unit root tests in ARMA Models with data-dependent methods for the selection of the truncation lag. J Am Stat Assoc 90:268–281

    Article  Google Scholar 

  • Ng S, Perron P (2001) Lag length selection and the construction of unit root tests with good size and power. Econometrica 69:1519–1554

    Article  Google Scholar 

  • O’Hara M (2003) Presidential address: liquidity and price discovery. J Financ 58:1335–1354

    Google Scholar 

  • Pascual R, Pascual-Fuster B, Climent F (2006) Cross-listing, price discovery and the informativeness of the trading process. J Financ Mark 9:144–161

    Article  Google Scholar 

  • Persyn D, Westerlund J (2008) Error-correction-based cointegration tests for panel data. Stata J 8:232–241

    Google Scholar 

  • Phillips PCB, Perron P (1988) Testing for a unit root in time series regression. Biometrika 75:335–346

    Article  Google Scholar 

  • Silva AC, Chávez GA (2008) Cross-listing and liquidity in emerging market stocks. J Bank Financ 32:420–433

    Google Scholar 

  • Stock JH, Watson MW (1988) Testing for common trends. J Am Stat Assoc 83:1097–1107

    Article  Google Scholar 

  • Su Q, Chong TT (2007) Determining the contributions to price discovery for Chinese cross-listed stocks. Pac Basin Financ J 15:140–153

    Article  Google Scholar 

  • Von Furstenberg GM, Tabora CB (2004) Bolsa or NYSE: price discovery for Mexican shares. Int Financ Mark Inst Money 14:295–311

    Article  Google Scholar 

  • Westerlund J (2007) Testing for error correction in panel data. Oxf Bull Econ Stat 69:709–748

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Economics, Finance, and Marketing, Tennessee Technological University, 1 William L. Jones Drive, Cookeville, TN, 38505, USA

    Alma D. Hales

Authors
  1. Alma D. Hales
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Alma D. Hales.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Hales, A.D. Liquidity and price discovery in Latin America: evidence from American depositary receipts. J Econ Finan 39, 661–678 (2015). https://doi.org/10.1007/s12197-013-9270-2

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s12197-013-9270-2

Keywords

JEL Classification

Search

Navigation