Determinants of premiums of Indian ADRs: An empirical investigation.

Empirical literature has documented that there does not exist scope for arbitrage profit for the cross-listed ADRs of developed countries (Foerster and Karolyi, 1999). Whereas, even after the introduction of twoway fungibility in 2002, almost all Indian ADRs trade at high premium levels - above the transaction cost band indicating scope for arbitrage profit (Majumdar,2007). However, that does not imply that the Indian ADRs and domestic markets are perfectly segmented and no conversion / re-conversion takes place between ADRs and the domestic stocks. The existence of arbitrage has been identified by practitioners (e.g. fund managers in US) long ago (Knauk 2007). Against this backdrop, we study about 5 years of daily data on opening and closing prices of 9 Indian ADRs. Multiple Regression and VECM are used to examine the following: Movements in which market causes the change in ADRs premium levels? How liquidity, trading volume, volatility and turnover in both the markets influence the change in ADRs premium levels? Is there any structural break? If yes, why? Whether the 'headroom' clause is solely responsible for the existence of premia? What are the transaction cost bands for Indian ADRs? Whether FII trading in the domestic market has any influence on the premium levels of the ADRs? Our initial findings suggest the influence of US market is more on ADRs returns than Indian market. The premium-levels of the Indian ADRs change over time. The changes are in tandem with the changing levels of market indices. Inverse relationship exists between domestic market turnover and ADRs premiums. There are evidences of structural breaks in the level of ADRs premiums. [ABSTRACT FROM AUTHOR]