Arbitrage Opportunities in the American Depository Receipts Market Revisited

Abstract

We examine whether profitable arbitrage opportunities exist in the American Depository Receipts Market. The arbitrage strategy calls for extablishing long and short positions in identified portfolios of over- and under-priced securities. Two alternative portfolio weighting schemes are adopted: equal weights and mean variance efficient weights. An unbiased test for arbitrage should account for possible risk differentials of the long and short positions. We undertook two perturbations in forming alternative arbitrage portfolios combining the long and short positions: minimum-variance and an equally-weighted combination. The null hypothesis of no arbitrage is rejected. Annualized arbitrage returns between 1.23% and 4.44% were possible for some of the identified arbitrage portfolios. Whether such a seeming anomaly is of economic importance will depend on transaction costs faced by the potential arbitrageur.