Abstract:
We investigate the relative advantages of American depositary receipts (ADRs), the
underlying Australian stocks and the Australian equity index for a US investor seeking
international diversification. We find that the ADR market is priced efficiently that the 'law
of one price' holds. However, ADRs have an economically significant higher reward/risk
ratio than underlying stocks, partly due to lower transactions cost. ADRs have a low
correlation with the US market under high states of global and regional shocks. Portfolio
managers could use the ADRs directly in enhanced indexing strategies. The dominant
information flow is found to occur from the underlying stocks to the ADRs, while at the
aggregate level the information flow is primarily from the US to the Australian market.
