Asynchronous ADRs: Overnight vs Intraday Returns and Trading Strategies

American Depositary Receipts (ADRs) are certificates, denominated in U.S. dollars, that represent shares of non-U.S. company securities. There are about 2000 ADRs traded on U.S. exchanges, namely NYSE and NASDAQ, or through the over-the-counter (OTC) market, representing shares of companies from at least 70 different countries. ADRs are among the most direct and popular financial instruments for investing in foreign companies, and have been actively used to diversify portfolios. In 2015, foreign equity holdings – through ADRs and local shares – accounted for 19% of U.S. investors’ equity portfolios. Specifically, total global investments in DRs, both American and non-American, were estimated to be approximately $1 trillion USD, with about 90% specifically in ADRs, according to reports by JP Morgan. Some of the most traded Exchange-Traded Funds (ETFs) are comprised of ADRs as well. For instance, 14 Chinese ADRs were added to the MSCI Emerging Market Index in late 2015. The iShares MSCI Emerging Markets ETF (EEM), which tracks this index, has a market capitalization of $24 billion and daily average volume of 72 million shares.

Due to their cross-border nature, ADRs’ returns are significantly dependent on the market sentiments of both the U.S. and originating home markets. Especially, ADRs from Asian countries, such as Japan, Hong Kong, China, Taiwan, India, and Korea, are of particular interest for two reasons. First, these ADRs provide U.S. investors with direct viable means to invest in foreign and emerging markets. Consequently, Asian DRs listed on non-Asian exchanges accounted for over 44% of the total DR market capitalization by the third quarter of 2015.

Second, the time zones for the aforementioned countries are 13 to 14 hours ahead of New York’s Eastern Standard Time (EST). Therefore, the trading hours of the U.S. market and their home markets do not overlap. The originating home markets open after the U.S. market closes and vice versa. This leads to not only their asynchronous returns with underlying equities but also the price fluctuations during and after the U.S. market hours. The connection (or contrast) between completely asynchronous markets has been of particular interest to especially multi-asset investors and other institutional investors.

Similarly, the time zone discrepancy allows us to split their returns into intraday and overnight components, each with fundamentally different price driving factors. For the Asian ADRs studied herein, intraday returns can be intuitively attributed to the news, conditions, and outlook of the U.S. market, whereas overnight returns are predominantly driven by the local Asian markets. We seek to understand the volatility contribution by different effects from each market.

Kang and Leung (2016) analyze the salient characteristics of ADRs, including the key statistics of the intraday returns and overnight returns, their distributions and correlations with the U.S. market. In particular, the correlation of each ADR with respect to the U.S. market is useful since it can serve as the basis of some trading strategies. Since intraday returns reflect price fluctuations during the U.S. market hours, they are expected to have a relatively high correlation with the U.S. market returns. On a similar note, overnight returns are expected to have a significantly lower correlation. The study determines these correlations, quantitatively contrast their effects on the overall volatility and performance of each ADR. Most importantly, pair trading strategies are developed and back tested to take advantage of the path behaviors of asynchronous ADRs. The paper is available in pdf here:

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