Methodology and Data

Depositary receipts (DRs, also known as American Depositary Receipts or ADRs) are shares of non-US corporations traded in the US, while the underlying shares are traded in the issuer's domestic market. DRs are issued by so-called depositary banks in the US and represent a specific number of underlying shares remaining on deposit in so-called custodian banks in the issuer's home country.⁹ The depositary bank can create a new DR by depositing the required number of shares in the custodian bank, after which, the dividends and other payments will be converted by the depositary bank into US dollars and thus be made available to the holders in the US. The process can simply be reversed by canceling or redeeming the DR. In this way, an underlying stock can easily be transformed into a DR and vice versa.

The cross-market premium, defined as the percentage difference between the dollar price of the stock in the domestic market and its corresponding DR, reflects the deviation between the home market price of the stock and its price in New York. The cross-market premium can be computed by converting the local currency price of the underlying stock to dollars, multiplying it by the number of underlying shares one DR represents, and then dividing it by the DR price.

When there are no barriers to cross-country capital movement between the domestic market and the US, there are no transaction costs. Furthermore, if the two markets close at the same time, arbitrage should be instantaneous and costless and prices should be equal. If the price of the underlying stock is higher than the price of the DR, investors can make an instant profit by buying the DR, transforming it into underlying stock, and selling it. This will lower the price of the underlying stock and bring the premium back to zero. The reverse holds when the price of the DR is higher. If a shock occurs too late in the day to be arbitraged away, closing prices will differ, but this difference will disappear quickly the next trading day.¹⁰ In reality however, instantaneous and costless arbitrage does not exist. Many factors can affect arbitrage, including capital controls and crises, as mentioned above.

In order to examine how the cross-market premium reacts to capital controls and crises, we conducted event studies. These studies allowed us to determine whether the cross-market premium behaved statistically differently after an event. We did this in two ways: first, we constructed a portfolio of stocks and studied its evolution, then at the stock level, we computed the estimated post-event deviations from the pre-event mean and variance values. We then reported the mean and variance differences and the number of stocks for which these differences were statistically significant.

We analyzed the following events: the imposition and lifting of capital controls, significant relaxations in the intensity of capital controls, and crises. In the case of capital controls, the event date (time zero) is marked as the date capital controls change (i.e., they are introduced, lifted, or relaxed). Six-month windows before and after the event were used to calculate the pre-event and post-event means. In the case of crises, we defined the event as the beginning of a crisis, and studied the behavior of the cross-market premium during the crisis period relative to the pre-crisis mean. The lengths of the post-crisis windows are equal and are determined by the duration of the crisis.

In terms of data, we worked with countries that experienced changes in capital controls or financial crises during the sample period, so that we were able to analyze the effects of both. We also worked with stocks with a long history of DR listings with important trading volume. Thus, we used publicly traded stocks in the US, either on the National Association of Securities Dealers Automated Quotation System (NASDAQ) or the New York Stock Exchange (NYSE). In total, we worked with 98 stocks (out of 133 DRs that trade in the NYSE and NASDAQ) from nine emerging economies: Argentina (8 stocks), Brazil (30 stocks), Chile (20 stocks), Indonesia (2 stocks), Korea (6 stocks), Mexico (23 stocks), Russia (2 stocks), South Africa (8 stocks), and Venezuela (3 stocks). The cross-market premium was calculated only on days when both the underlying stock and the DR were traded.¹¹

The data needed to calculate the premium (the dollar price of the stock in the domestic market, the price of the DR in New York, and the number of underlying shares per unit of the DR) came from Bloomberg. For Argentina, Brazil, Chile, and Venezuela we used the closing price both in the domestic market and in New York. For Asian markets, which are already closed when the New York stock market opens, as well as for Russia and South Africa, we instead used the closing price (and the exchange rate) in the domestic market and the opening price in New York, to minimize distortions due to time differences.

Before studying the effects of capital controls and crises on the integration of emerging economies in the next sections, it is useful to observe the behavior of the cross-market premium during tranquil (non-crisis) times when capital controls are absent. Table 1 [ PDF 14KB | 1 page ] presents summary statistics of the simple average of the cross-market premium of the stocks in each country's portfolio. A positive premium indicates that the price of the underlying stock exceeds that of the DR, while a negative premium indicates otherwise. The table shows that during tranquil times, the premium is generally close to zero. In all cases, except in Korea, the average premium is below 1%. The summary statistics of all stocks show a mean of 0.12%, with a standard deviation of 0.73. In other words, during tranquil times and under no controls, emerging economies seem well integrated with the international capital market.

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