J.of Multi.Fin.Manag.18(2008)
165–179
Available online at
Foreign exchange rate exposure and risk premium in international investments:Evidence from
American depositary receipts
Sung C.Bae a,∗,Taek Ho Kwon b,Mingsheng Li a
a Department of Finance,Bowling Green State University,Bowling Green,OH43403,USA
b Department of International Commerce,Chonnam National University,Yosu,Chonnam,Republi
c of Korea
Received15May2006;accepted2July2007
Available online12July2007
Abstract
We examine how exchange rate changes affect the curity returns and how economic and translation exposure components of exchange rate risk are priced across countries.Employing ADRs of four countries, we document four mainfindings.First,exchange rate changes are negatively related
to underlying share returns of ADRs,but positively to ADR returns obrved in the U.S.markets.Second,ADR returns are more cloly related to local market returns than U.S.market returns,indicating that the local market environment plays a bigger role in determining ADR returns.Third,U.S.and local investors require different risk premiums for exchange rate risk prent in ADR investments.Fourth,both the source(economic or translation exposure) and magnitude(high or low)of the exchange risk premium vary across countries.We obtain robust empirical findings for both country ADR portfolios and individual ADRs.
©2007Elvier B.V.All rights rerved.
JEL classification:F31;G15
Keywords:Foreign exchange rate exposure;Foreign exchange risk premium;American depositary receipts
∗Corresponding author.Tel.:+14193728714;fax:+14193722527.
E-mail address:bae@bgsu.edu(S.C.Bae),thk5556@chonnam.ac.kr(T.H.Kwon),mli@bgsu.edu(M.Li).
人种智商排名1042-444X/$–e front matter©2007Elvier B.V.All rights rerved.
doi:10.1016/j.mulfin.2007.07.001
生肖三合是什么意思
166S.C.Bae et al./J.of Multi.Fin.Manag.18(2008)165–179
1.Introduction
The surge in investments in American depositary receipts(ADRs)has instigated considerable rearch on this subject.1Existing literature on ADR can be classified into four broad areas:(1) arbitrage opportunities between the prices of ADRs and their underlying curities.Kato et al. (1991)and Wahab et al.(1992)find that few profitable opportunities exist after transaction costs;
(2)factors affecting ADR prices.Studies by Jiang(1998)and Kim et al.(2000)suggest that the variation in ADR returns can be explained by three factors:U.S.market returns,local market returns,and exchange rate changes;(3)price transmission dynamics between ADRs and their underlying curities.While Jiang(1998)shows that ADRs and their local shares influence each other,Kim et al.(2000)obrve that most respons of ADRs to the unexpected price movements of underlying shares occur on the same calendar day;and(4)diversification gains from ADRs. Alaganar and Bhar(2005)indicate that ADRs have a low correlation with the U.S.stock market and thus provide an effective tool for U.S.investors to achieve portfolio diversification.
Given the large body of literature on ADR,veral important issues still need to be addresd. Althou
gh it is well known that afirm’s exchange rate risk consists of three components of eco-nomic exposure,translation exposure,and transaction exposure,2limited evidence exists on how exchange risk exposure in general and its components in particular affect the pricing of ADRs. Furthermore,it is not clear how the U.S.investors’risk attitude toward exchange risk affects their pricing of ADRs from different countries.
In this study,we extend the existing literature on ADRs in veral ways.First,unlike previous studies,we examine not only how exchange rate changes affect ADR returns in the U.S.market but also the underlying share returns of ADRs in the local markets.This analysis is important becau it would provide relevant information on the exchange risk premium required by U.S. investors relative to local shareholders.
Second,we take a further step to investigate how each of the two exchange risk components, economic exposure and translation exposure,affects ADR returns.In ADR investments,the economic exposure reprents the changes in the underlying share returns of ADRs to changes in exchange rates,and the translation exposure reprents the exchange risk associated with translating the underlying share returns in local currency into the returns in the U.S.dollar. Dintangling the effects of the two exchange risk components would enable investors to better understand the sources of AD
R returns and the related risk,which,in turn,helps ADR investors construct better investment portfolios.3
Third,we examine the effects of exchange rate changes and exchange risk components on the ADR returns of four countries including Australia,France,Japan,and the U.K.The cross-
1According to Bank of New York,the annual trading volume of ADRs and other depositary receipts listed on U.S. exchanges incread from US$75billion in1990to US$1185billion in2000,implying an annual growth rate of31.8% (e the Bank of New York2000Year End Market /dr pub statistics.jsp).
2Economic exposure reprents the nsitivity of afirm’s competitiveness to the changes in exchange rates,translation exposure reprents the uncertain gains or loss when foreign currency asts are converted to home currency,and transaction exposure reprents the nsitivity of afirm’s realized domestic currency value from thefirm’s contractual foreign cashflow.
3For example,a depreciated foreign currency will improve a foreign exportingfirm’s competitiveness in the world market and thus increa thefirm’s underlying value through incread cashflows.For U.S.ADR investors,however, the same depreciated foreign currency becomes less valuable.Thus,the
translation loss to ADR investors could offt or overweigh the gain in the localfirm’s underlying value;conquently,the underlying curity could be a good investment for local investors but not for U.S.investors.
S.C.Bae et al./J.of Multi.Fin.Manag.18(2008)165–179167 country comparison helps enhance our understanding of how the U.S.investors’risk attitude(or ntiment)toward foreign exchange risk differs across different countries.
Finally,the rearch methodology and sample period in our study are distinguished from tho in many of prior studies.The two-step method ud in this paper has a distinctive advantage of examining the process of pricing foreign exchange risk in a clear manner without directly resorting to the multi-factor CAPM.Furthermore,our sample period covers1999–2001,during which the increa of U.S.investment in ADRs reached the peak point,reflecting U.S.investors’growing optimism and confidence in ADRs.Thus,the results bad on this sample period will provide renewed information regarding U.S.investors’risk attitude toward ADR investments.
Our study has important implications.For foreignfirms that ekfinancing in the U.S.capital market,the exchange risk premium required by U.S.ADR investors directly affects their cost of capital.
For U.S.investors,understanding of the effect of exchange rates on ADR returns in addition to the prices of underlying shares and U.S.market returns will help them better design their global investment portfolios.
Our results show that underlying share returns of ADRs are significantly negatively expod to exchange rate changes for France,Japan,and the U.K.,but significantly positively for Australia. The negative effect in general suggests that the underlyingfirm value is adverly affected by the appreciation of local currency against the U.S.dollar.On the contrary,ADR returns are significantly positively related to exchange rate changes for all four countries,implying that a foreign currency appreciation against the U.S.dollar benefits the U.S.ADR investors becau of the translation gains.
As for risk premium,wefind that the source and magnitude of foreign exchange risk pre-mium vary significantly across countries.The significant differences in exchange risk pricing for Australian and French ADRs are cloly related to the economic exposure component of the exchange rate risk,but the significant pricing differences for Japane ADRs are cloly related to the translation exposure of the exchange rate risk.
2.Development of testable hypothes
As the economic globalization continues and the world markets become more integrated,the price of the underlying share(P SHARE)of an ADR is formally determined as:
P SHARE=f1(local market conditions,economic exposure)(1) If markets were perfectly efficient and internationally integrated with no divergent expectation on information among investors,the ADR price(P ADR)should be equal to the price of the respective underlying stock(P SHARE)adjusted for exchange rates(S),i.e.,P ADR=P SHARE×S,深处作文
assuming that transaction cost is minimal.However,the world markets may not be perfectly integrated,and information asymmetry could possibly exist between local investors and U.S. ADR investors.Hence,the relative optimism or pessimism of local versus U.S.investors may contribute to the difference between the two prices.
In addition,different sources of foreign exchange risk investors face will also lead to a different pricing of the exchange risk associated with ADRs.In ADR investments,changes in exchange rates affect both the return-generating process of the underlying shares(economic exposure)and the return translation of local currency into U.S.dollars(translation exposure).The translation exposure is additional exchange risk borne by U.S.investors.
168S.C.Bae et al./J.of Multi.Fin.Manag.18(2008)165–179
Following the ,Jiang,1998;Kim et al.,2000),the price of the ADR(P ADR)can be expresd as:
P ADR=f2(P SHARE,U.S.market conditions,translation exposure)(2a) Of the three pricing factors for ADRs,the underlying share price(P SHARE)and translation exposure are obvious since an ADR reprent a certain number of the underlying shares,which are translated into U.S.dollar for the U.S.investors.Although less obvious,U.S.market conditions also affect the ADR price.For example,Kim et al.(2000)note that U.S.market conditions affect ADR prices in two possible ways.First,U.S.investors evaluate the systematic risk of ADRs with reference to the U.S.market conditions.Second,the non-synchronous trading of ADRs(in the U.S.market)and their underlying shares(in foreign markets)could also make the U.S.and foreign markets correlated.Several empirical studies provide evidence in support of this , Jiang,1998;Suh,2003).
As discusd above,exchange rate movements affect ADR prices in two ways via the eco-nomic exposure and the translation exposure components.This relation can be easily shown by substituting P SHARE in Eq.(2a)with f1in Eq.(1)and rearranging it as:
P ADR=f2(local and U.S.market conditions,economic exposure,translation exposure)(2b) Bad on above discussions,we posit Hypothesis1as follows:
Hypothesis1.After controlling for the local and U.S.market conditions,the difference between an ADR price and its underlying share price adjusted for exchange rate changes reflects U.S. investors’required risk premium on the economic exposure and translation exposure components.
To the extent that different countries are at different stages of economic andfinancial develop-ments and have different political environments,we conjecture that U.S.investors’risk attitude (or ntiment)toward investing in ADRs also varies across different countries.Hence,we posit our cond hypothesis as follows:
Hypothesis2.U.S.investors price differently the exchange rate risk of ADRs from different countries.The differences reflect the U.S.investors’different risk attitude(or ntiment).
3.Data
溃退造句
The preliminary sample of our study consists of all foreignfirms that issued Level II(listing) or Level III(offering)ADRs on the NYSE over the four-year period of1998–2001.Level I ADRs are excluded sin
ce they are traded in the OTC market.In addition,ADRs traded on the AMEX or NASDAQ are excluded due to their substantially smaller sample size and low liquidity.4Since Australia,France,Japan,and the United Kingdom offer the largest number of ADRs on the NYSE, we focus on ADRs from the four countries.The number of ADRs(Levels II and III)listed for the four countries during the entire sample period are11,10,11and41for Australia,France, Japan,and the U.K.,respectively.After excluding ADRs without relevant data,thefinal sample includes10ADRs for Australia,9ADRs for France,10ADRs for Japan,and25ADRs for the U.K.Price data are collected from the DataStream and are checked using the CRSP Daily Return 4In2001alone,1558DR programs were offered globally,of which623DR programs were listed on hanges with annual trading volume of US$752billion(e /adr).
S.C.Bae et al./J.of Multi.Fin.Manag.18(2008)165–179169 File.Exchange rates,Euro rates,and market rates of return in local markets are also collected from the DataStream.
We choo the sample period from1998to avoid or minimize at least the effect of the Asian financial crisis of1997.For empirical analysis in our study,we u weekly price data in order to mitigate the potential non-synchronous trading problem associated with daily price data.We collect Friday’s closing prices to construct a weekly data ries for all variables except for the daily exchange rates a
解决的拼音nd underlying share returns that are ud to estimate covariance risk of exchange rates and share returns.5Furthermore,as a way to alleviate any potential idiosyncratic problem and focus on country characteristics,we construct equally-weighted portfolios of underlying shares and ADRs for each of the four countries.
4.Empirical methods and results汽车点烟器
bear英语怎么读4.1.Summary statistics
Table1reports means and standard deviations of veral variables of interest for each country computed with weekly data.The local market index return is the rate of return of each country’s lected stock market index:All Ordinary index for Australia,CAC40index for France,Nikkei 225index for Japan,and FTSE100index for the U.K.For comparison purpo,the S&P500 index is ud for the U.S.Exchange rate changes are weekly changes of U.S.dollars per unit of each country’s currency.Three-month Eurocurrency interest rates are ud as risk free interest rate for each country.For consistency,Eurodollar rates are ud as risk free interest rate for the U.S.
As shown in Table1,the local market index return,underlying share return,and ADR return are on average positive for Australia and France over the1998–2001period,but the local market index and A
DRs for the UK produce a negative mean return.Both Japane ADRs and their underlying stocks experience relatively large negative returns,consistent with the sluggish Japane economy during the four-year period.Thefindings on exchange rate changes show that during the four-year period,the value of all currencies except for Japane yen depreciates against the U.S.dollar.
4.2.Estimation of foreign exchange rate exposure反腐倡廉建设
Following Jorion(1990),we estimate foreign exchange rate exposure of underlying shares in the local markets using the following time-ries regression model for each country: UNDR t=a0+a1LMR t+a2EXR t+e t(3) where UNDR is the rate of return of underlying stock;LMR is the rate of return of local stock market;and EXR is the rate of exchange rate changes expresd in U.S.dollars per local currency unit.In Eq.(3),the coefficient of EXR,a2,measures exchange rate exposure of an underlying share,that is,the economic exposure component.
Similarly,we estimate foreign exchange rate exposure of ADRs in the U.S.market by:
ADRR t=b0+b1LMR t+b2USMR t+b3EXR t+u t(4)
5Several studies employ weekly data in investigating premiums prent in country ,Bodurt
ha et al.,1995; Chandar and Patro,2000).One may doubt that the results bad on Friday’s closing prices could be biad due to the end-of-week effect.To check this issue,we also conducted our empirical analys using Wednesday’s closing prices and found results qualitatively similar to tho reported in our study with slightly lower adjusted R2.
170S.C.Bae et al./J.of Multi.Fin.Manag.18(2008)
165–179Table 1
Mean and standard deviation of variables by country
Country Local market index return (%)Underlying stock return (%)ADR return (%)Exchange rate change (%)Risk-free interest rate (%)No.of ADRs
Australia 0.1290(1.8619)0.1906(2.6094)0.0387(3.2313)−0.1170(1.6779)0.0993(0.0118)10France 0.2017(3.3132)0.1597(3.9151)0.0617(3.9354)−0.1005(1.4193)0.0729(0.0139)9Japan −0.1778(3.1124)−0.0658(3.6157)−0.0965(3.8101)0.0041(2.0638)0.0054(0.0044)10U.K.−0.0045(2.5816)0.0181(2.4936)−0.0553(2.4772)−0.0599(1.0589)0.1148(0.0187)25U.S.0.0839(2.8780)0.1015(0.0226)N.A.Mean and standard deviations are on a weekly basis measured using weekly data from January 1998to December 2001with a total of 208return data obrvations;standard deviations are in parenthes.
