Price clustering and economic freedom: The case of cross-listed securities

Abstract

This study develops and tests the hypothesis that economic freedom in a particular country can explain the level of price clustering in financial markets. The hypothesis is motivated by the idea that the lack of economic freedom may create uncertainty, which motivates investors to settle on round prices. Using a broad sample of American Depositary Receipts (ADRs), we find that the level of price clustering in ADRs is decreasing in the economic freedom of the home country. The economic freedom components that have the largest effects are the level of regulation and the stability of monetary policy in the ADR home country. To make stronger causal inferences, we examine the price clustering of Japanese, vis-à-vis non-Japanese, ADRs in response to an event that tightened regulation in Japanese money markets. Results show that, relative to non-Japanese ADRs, the price clustering of Japanese ADRs meaningfully increases in response to this change.