Cross-border trading as a mechanism for implicit capital flight: ADRs and the Argentine crisis

Abstract

Cross-listed shares may confound government efforts to control capital outflows by providing a legal means through which investors can transfer their wealth outside the country. We study the recent experience of investors in Argentina and Venezuela who while subject to capital controls, were able to purchase cross-listed shares using local currency, convert the shares into dollardenominated shares, re-sell them in New York and deposit the dollar proceeds in U.S. bank accounts. We show that capital controls drive a wedge between the price of local shares and their corresponding cross-listed shares. This anomalous wedge provides a measure of the market's implicit devaluation forecast and the value of capital control circumvention. We also find that the imposition of controls in Argentina led to changes in the underlying pricing structure of crosslisted shares in Buenos Aires and New York.

Crises, contagion and cross-listings

“…These financial controls were intended to ward off a devaluation of the peso, effectively providing incentives for Argentineans to invest in their domestic stock market. According to Auguste et al (2006), (page 2) ''in contrast to the experiences of other emerging markets, the crisis appears to have 'good news' for the Argentinean stock market". They also find that local market factors became more important in pricing CL stocks in Argentina.…”

A Market-Based Indicator of Currency Risk: Evidence from American Depositary Receipts

“…Several interesting studies consider the capital control episode in Argentina 2001/02 and find that prior to the devaluation of the peso, ADRs were traded at a price discount relative to their corresponding underlying stocks (e.g. Melvin (2003); Kadiyala (2004); Levy Yeyati et al (2004); Auguste et al (2006); Eichler et al (2009)). Melvin (2003), Levy Yeyati et al (2004) and Auguste et al (2006) attribute this finding to the fact that Argentinians were willing to pay a premium on domestic stocks in order to convert them into ADRs and then cash them into U.S. dollars -a legal way to circumvent the capital controls.…”

“…Melvin (2003); Kadiyala (2004); Levy Yeyati et al (2004); Auguste et al (2006); Eichler et al (2009)). Melvin (2003), Levy Yeyati et al (2004) and Auguste et al (2006) attribute this finding to the fact that Argentinians were willing to pay a premium on domestic stocks in order to convert them into ADRs and then cash them into U.S. dollars -a legal way to circumvent the capital controls. Kadiyala (2004) and Eichler et al (2009), on the other hand, argue that this relative discount reflects the market expectations of the true exchange rate that would result after the breakdown of the peg.…”

“…Our currency risk indicator therefore has the advantage of reflecting forward looking currency risk assessments that are available at a high frequency and in real time. Second, in contrast to existing approaches in the ADR literature that use relative price levels (Melvin (2003); Kadiyala (2004); Levy Yeyati et al (2004) ;Auguste et al (2006); Arquette et al (2008); Eichler et al (2009)), our measure is not restricted to capital control episodes. We consider the currency risk factor priced in ADR returns, which can also be derived for periods without restrictions on capital flows.…”

The proof is in the pudding: Arbitrage is possible in limited emerging markets

“…There is no restriction on the conversion of Argentinean stock to ADRs(Auguste et al, 2006), and such conversions have been shown to aid capital flight during Argentinean crisis. This is the same case in Egypt, as supported by data obtained from the Egyptian Depository and Clearing House.…”