Are Indian ADR Premiums Mispriced?

Abstract

Purpose: Indian ADRs have been observed to trade at premiums to the price of the underlying shares flouting the law of one price theorem. Therefore, it becomes imperative to investigate whether the observed premiums are mispricing or investor demand. This paper examines the Indian ADRs trading at a significant premium for an extended period.
 Methodology: The paper studies all ten Indian ADRs traded from 2001 to 2006. It uses NYSE Trade and Quote Database to compute order imbalance for analysis of the mispricing. It employs multivariate regression models to examine the premiums.
 Findings: The results suggest that Indian ADR returns are closely associated with the underlying market returns. Premiums are negatively related to the underlying stock returns. The ADR prices only adjust partially to the prices of the underlying stock. The ADR and underlying stock have a separate process for price formation in their respective markets. Using order imbalance of small and total trades of ADRs, this study shows that Indian ADR premiums are significantly and positively related to the buy demand of investors. Overall, the results support the idea that investor demand drives the Indian ADR premiums and is not mispriced.
 Unique Contribution to Theory, Policy, and Practice: The study provides valuable information on the same security traded in different trading locations and market segmentations. It offers insight into an emerging market stock listed in the most developed financial markets. It expands the literature on order imbalanced and dual-listed securities, particularly for ADRs. The order imbalance can be decomposed into short- and long-run components, showing how both parts influence ADR returns and premiums/discounts.