ADR Arbitrage Across Currencies and Class Structure: Evidence from Ericsson in USD, SEK, and EUR

Ericsson is currently dual listed in Stockholm in SEK, New York in USD, and Frankfurt in EUR.  The SEK shares consist of A and B classes, while the USD and EUR listed shares are both equivalent to the SEK class B shares.  This is a basic ADR structure traded through 3 currency pairs and 2 different class structures.

As evidenced in the first chart below, at the time of the recording, the USD-listed ERIC shares were equivalent in price to the SEK-listed ERIC.B shares.  Note the ERCB shares correspond to the right axis and trade at a roughly 50% discount to USD shares.  The Class A SEK-denominated ERIC.A shares trade at a discount to their own and USD-listed B Class equivalents.

This study incorporated the cash markets for the EUR/USD, EUR/SEK, and USD/SEK exchange rates.  The principles of triangular arbitrage were incorporated to derive values across the structure.

The Currency Adjusted USD-value Shares:

The US-listed shares register a bid/ask as early as 3am CST and track the SEK-listed B shares.  

The Currency Adjusted Openings:

As is usually the case for these studies, the outright share prices correspond to the left axis, while the spread value corresponds to the right axis.

USD-listed shares vs. SEK-listed A and B Class shares.

EUR-listed B Class shares vs. USD-listed B Class shares.

EUR-listed B Class shares vs. SEK-listed A and B Class shares.

A closer look at the turbulence in the bid/ask of the EUR-listed ERCB shares.  I believe this is similar in nature to some of the research posted by Nanex.

And in the closing 5 minutes, the SEK-listed ERIC.B shares experience some unusual turbulence.  I don't like to speculate because this could have happened for any number of reasons (data integrity, software integrity, etc.), but judging by the increase in the bid/ask spread of the ERCB shares (EUR-listed), the market maker appears to have known it was coming.

A closer look at the overall spreads during the 8:30-10:30am CST market overlap. Again, in order as before.

USD-listed shares vs. SEK-listed A and B Class shares.

EUR-listed B Class shares vs. USD-listed B Class shares.

EUR-listed B Class shares vs. SEK-listed A and B Class shares.

Further Reading:
ADR Market Timing: In Which Market Do Issuers Possess Better Market-Timing Ability and what is the Role of Regulations?
Impact of ADR Listing on the Trading Volume in the Domestic Market

Round the Clock Price Discovery: Evidence from Infosys and USDINR Futures

Infosys is dual listed in USD on the Nasdaq (INFY) and in INR on the National Stock Exchange of India (NSE) (INFY).  I do not have access to any spot INR facilities, however I do have available some NSE listed USD/INR futures.  These futures allow for the currency-adjusted value of either equity to be derived.  Similar price transmission studies have been discussed using prices from Glencore, RWE, Apple, and Sino-Forest, all four however using the spot FX as the pricing mechanism.

The two shares outright:

A European-listed, EUR-denominated equity would be advantageous for price transmission.  Further study could include the viability of using a EUR-denominated tech sector ETF as a pricing mechanism for the risk inherent between NSE and Nasdaq trading times.  

Research of this nature is, to date, inconclusive and will be continuous.

Cleaned up prices on Sino-Forest

Prices from July 26, 2011. 

Apple Arbitrage on Job's Resignation

Apple is dual listed on the Deutsche Bourse in Euros and the Nasdaq in USD.  The shares trade at a currency adjusted 1:1 ratio.  This is the arbitrage between the shares on the day following Job's resignation announcement.    This is the USD-listed shares combined with the implied price of the currency adjusted EUR-listed shares.

The live USD value, the currency-adjusted EUR value, and the arbitrage spread between them is shown below from 8:30am - 10:30am CST.  This relationship is strongest during the overlapping hours when both markets serve as liquidity hubs for cross market arbitrageurs.  

The EUR/USD spread during the overlapping hours.

While the news of Job's resignation was simultaneously priced into both shares during the overnight trading, price transmission and liquidity introduction is evident in the hour surrounding the U.S. market openings.

A minor deviation can be seen in the opening 2 minutes of U.S. trading.  

A Quick look at Sino Forest

Lots of talk about Sino Forest lately.  Paulson, once an investor in the firm, appears to have gotten out.  However Richard Chandler appears to have gotten in.  Needless to say, there's been some turmoil in the shares, which happen to be dual listed in the US and Canada.  Shares trade under the tickers SNOFF and TRE, and are listed in USD and CAD respectively.  The following are built from trade-and-quote (TAQ) data recorded July 26, 2011.  

The arbitrage relationship between the implied CAD value of the USD-listed shares and the real CAD-listed shares breaks momentarily during the open.  This deviation from parity meant that the CAD shares could have been sold 15 cents above the relative value of USD shares.  

Opening 5 Minutes

Opening 30 Minutes

Full Trading Day

Arbitraging the Arbitrageur: The Case of Glencore

Glencore is dual listed on the Hong Kong (805) and London (GLEN) stock exchanges.  The shares are listed in HKD and GBP, respectively.  The stock is scheduled to be listed in the U.S. denominated in USD eventually under the ticker GLNCY, however these are currently unavailable for trading.

Due to the operating hours of each exchange, the two anchor stocks (805/GLEN) only overlap for one hour per day, from 2:00AM CT (U.S.) to 3:00AM CT.

This is the spread between LSE-listed shares converted to HKD and the actual HKD-denominated shares listed in Hong Kong.

Prices are from July 28, 2011.

How Knight Makes a Market: Evidence from RWE Group

Fond of trading on the OTC Bulletin Board, among other prominent markets, Knight Capital "trades or makes a market in over 19,000 U.S. Equities" according to their website.  The goal of this post, and I hope those going forward, is to examine the science behind Knight's activities.

The example today is RWE Group.  What they do and how they do it is wholly unimportant for this exercise.  The important and relevant data points to build on today are price and time.  Price for RWE quoted in Euros, RWEOY quoted in US dollars, the EUR/USD interbank rate, and the synchronized time stamps for all 3 variables.

Outrights: The two stocks together.  RWE (blue/red) is denominated in Euros and opens at 02:00AM while RWEOY (green/purple), denominated in US dollars, does not open until 08:30AM, despite a relatively tight bid/ask for the prior hour.  The chart below is April 8, 2011, from left to right, 2:00AM CST to 3:00PM CST.

Currency: The EUR/USD interbank currency rate available via IB's Idealpro.  The currency was recorded simultaneously with the two stocks to avoid using potentially stale quotes.

EUR/USD - 8 April, 2:00AM to 3:00PM CST

Implied Value.

Using the price of the shares denominated in Euros and the live EUR/USD exchange rate, a theoretical value for the USD-listed shares can be derived.  Gagnon and Karolyi (2004) provide an exhaustive study into this relationship.  The authors study 589 pairs of dual-listed stocks from 39 countries using daily closing prices from 1990 to 2002.  While most pairs are found to stay within a 15 to 20 basis point (.15% to .2%) range with one another, the authors note that "the premium on the cross-listed shares relative to home-market shares can be as large as 66 percent and the discounts as large as 87 percent," but deviations of such magnitude were found to last no longer than one day."

"Deviations from price parity,” they suggest, “their persistence over time and the excess comovements are related to country-level and firm-specific attributes that reflect, not only institutional impediments to arbitrage, but also informational barriers in the form of information asymmetries among different investors and the presence of noise traders."  They find that "excess comovements are significantly related to the fraction of global trading that takes place in the U.S. markets." Ejara and Ghosh (2004) support their findings and provided important research into the field.

Below is the implied value of RWE priced in USD combined with the live quoted price of RWEOY duly listed in USD. The market for RWEOY is most robust during the overlapping hours when market making firms are able to more easily transfer risk from one market to the other. The bid/ask spread of RWEOY after the European closing (on the right of the chart) is evidence of this mechanism.

April 8, 2011

July 15, 2011

Finding the difference between the synthetic value of RWE and the real value of the RWEOY is the arbitrage. In this case, as in others, dynamic inventory and risk management systems must be in place for the pricing participants.

Overlapping Market Spreads.

April 8, 2011 

July 15, 2011

Further Reading:

A Resolution of the Chinese Discount Puzzle

Arbitrage-Free Limit Order Markets and the Pricing of Order Flow Risk

Over The Counter Bulletin Board Exchange: The Impact of Liquidity and Size to Return, Volatility, and Bid/Ask Spread [pdf]