The Asymmetric Impacts of Currency Misvaluation on ADR Mispricing

We investigate the influence of currency purchasing power imparities on the mispricing of American Depository Receipts (ADRs). Existing literature is mainly silent on this issue, despite the important implications such imparities have for potential exchange rate changes—and by extension, the returns on ADRs. We carry out our investigation using panel data and a sample of 218 ADRs and their underlying assets from 24 countries over the period from 1985 to 2013. We find robust evidence for a statistically significant relationship between currency purchasing power imparities and ADR mispricing. We show that a highly overvalued U.S. dollar is associated with larger (lower) ADR premiums (discounts), while a highly undervalued U.S. dollar is associated with lower (larger) ADR premiums (discounts). The finding suggests that the demand for ADRs increases as the U.S. dollar becomes more overvalued, driving up the price of the ADRs versus the underlying stocks. Finally, the results demonstrate the importance of considering exchange rate states when investigating the impact of currency movements on ADR pricing. We estimate our results for several sub-periods, as well as sub-samples of developed and developing countries