Diversification with American Depository Receipts: The Dynamics and the Pricing Factors

Abstract

This paper studies the role of American Depository Receipts (ADRs) in international diversification by using a sample of 113 ADRs from eight foreign countries over 1980–1994. We find that investing in ADRs offers significant improvement in the risk‐return trade‐off. The effectiveness of ADRs as a vehicle for long‐term international diversification is further examined by performing cointegration analysis between ADR and the respective market portfolios. Consistent with Webb, Officer and Boyd (1995), we also find that the movements of ADR and the foreign market are highly correlated. Moreover, the pricing factors of ADRs are further investigated in a GARCH framework.