مواجهه با نرخ ارز خارجی و ریسک در سرمایه گذاری های بین المللی: مدارک و شواهد از رسیدهای سپرده آمریکایی

We examine how exchange rate changes affect the security returns and how economic and translation exposure components of exchange rate risk are priced across countries. Employing ADRs of four countries, we document four main findings. First, exchange rate changes are negatively related to underlying share returns of ADRs, but positively to ADR returns observed in the U.S. markets. Second, ADR returns are more closely 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 present 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.

The surge in investments in American depositary receipts (ADRs) has instigated considerable research on this subject.1 Existing literature on ADR can be classified into four broad areas: (1) arbitrage opportunities between the prices of ADRs and their underlying securities. 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 securities. While Jiang (1998) shows that ADRs and their local shares influence each other, Kim et al. (2000) observe that most responses 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, several important issues still need to be addressed. Although it is well known that a firm's exchange rate risk consists of three components of economic exposure, translation exposure, and transaction exposure,2 limited 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 several 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 because 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 represents the changes in the underlying share returns of ADRs to changes in exchange rates, and the translation exposure represents the exchange risk associated with translating the underlying share returns in local currency into the returns in the U.S. dollar. Disentangling the effects of the two exchange risk components would enable investors to better understand the sources of ADR 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-country comparison helps enhance our understanding of how the U.S. investors’ risk attitude (or sentiment) toward foreign exchange risk differs across different countries. Finally, the research methodology and sample period in our study are distinguished from those in many of prior studies. The two-step method used 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 covers 1999–2001, during which the increase of U.S. investment in ADRs reached the peak point, reflecting U.S. investors’ growing optimism and confidence in ADRs. Thus, the results based on this sample period will provide renewed information regarding U.S. investors’ risk attitude toward ADR investments. Our study has important implications. For foreign firms that seek financing 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 exposed to exchange rate changes for France, Japan, and the U.K., but significantly positively for Australia. The negative effect in general suggests that the underlying firm value is adversely 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 because of the translation gains. As for risk premium, we find that the source and magnitude of foreign exchange risk premium vary significantly across countries. The significant differences in exchange risk pricing for Australian and French ADRs are closely related to the economic exposure component of the exchange rate risk, but the significant pricing differences for Japanese ADRs are closely related to the translation exposure of the exchange rate risk.

In this study, we have examined two important issues on the foreign exchange rate exposure and risk premium associated with international investments in ADRs. Specifically, we test two hypotheses of (1) whether exchange rate changes have different impacts on the pricing of ADRs across different countries; and (2) whether U.S. investors price two components of exchange rate risk, economic exposure and translation exposure, in ADR investments differently than local investors. Our results show that after controlling for local market effects, underlying share returns of ADRs are in general adversely affected by exchange rate changes. In contrast, our results show that ADR returns are significantly positively related to exchange rate changes for all four countries, indicating that ADR returns move in the same direction as the corresponding foreign currency rates. Among the four countries, ADR returns of Australia are the most sensitive to changes in exchange rates, followed by those of Japan. Our results also indicate that while ADR returns are significantly positively related to returns of both the local market and the U.S. market, they are more closely related to the local market returns than the U.S. market returns. We also find that foreign exchange risk premiums vary significantly across countries with respect to the source (economic exposure versus translation exposure) and magnitude (low or high premium). Among others, Japanese ADRs offer contrasting evidence to other countries’ ADRs. While U.S. investors demand the same risk premium on the economic exposure component of the exchange rate risk as local investors, they demand greater risk premiums for the translation exposure component of the exchange rate risk than local investors do. Our results further help explain the closed-end country fund premium. For example, Bodurtha et al. (1995) attempt to explain the country fund premium using the investor sentiment factor that was introduced by Lee et al. (1991) in their study of the closed-end fund premium. Closed-end country funds, however, have unique features that distinguish them from other closed-end fund such as investor types. As country funds have similar characteristics to ADRs, our results suggest that the country fund premium may be explained by the difference in the exchange risk premium between foreign and local investors. In particular, a sharp increase in the country fund premium observed following the Asian currency crisis (see, e.g., Chandar and Patro, 2000) seems to be attributed largely to the different perception of exchange risk and hence the different exchange risk premium between foreign and local investor groups.