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Asynchronous ADRs: Overnight vs Intraday Returns and Trading Strategies Explained

Last Updated on 10 February, 2024 by Rejaul Karim

The paper “Asynchronous ADRs: Overnight vs Intraday Returns and Trading Strategies” by Tim Leung and Jamie Kang explores the dynamics of American Depositary Receipts (ADRs), exchange-traded certificates that represent shares of non-U.S. companies, primarily focusing on Asian ADRs within the context of asynchronous markets.

The study thoroughly analyzes the returns of these ADRs by dissecting them into intraday and overnight components in relation to U.S. market hours. Through empirical observations, the return difference between each ADR and the S&P500 index, traded via the SPDR S&P500 ETF (SPY), is identified as a mean-reverting time series and is subsequently fitted to an Ornstein-Uhlenbeck process using maximum-likelihood estimation (MLE).

The findings serve as a basis for developing and backtesting pairs trading strategies that exploit the mean-reverting ADR-SPY spreads, which consistently produce positive payouts when both long positions in ADRs and short positions in SPY are executed at optimal entry and exit levels.

Abstract Of Paper

American Depositary Receipts (ADRs) are exchange-traded certificates that represent shares of non-U.S. company securities. They are major financial instruments for investing in foreign companies. Focusing on Asian ADRs in the context of asynchronous markets, we present methodologies and results of empirical analysis of their returns. In particular, we dissect their returns into intraday and overnight components with respect to the U.S. market hours. The return difference between the S&P500 index, traded through the SPDR S&P500 ETF (SPY), and each ADR is found to be a mean-reverting time series, and is fitted to an Ornstein-Uhlenbeck process via maximum-likelihood estimation (MLE). Our empirical observations also lead us to develop and backtest pairs trading strategies to exploit the mean-reverting ADR-SPY spreads. We find consistent positive payouts when long position in ADR and short position in SPY are simultaneously executed at selected entry and exit levels.

Author

Tim Leung
University of Washington – Department of Applied Math

Jamie Kang
Columbia University; Stanford University

Conclusion

In conclusion, the paper “Asynchronous ADRs: Overnight vs Intraday Returns and Trading Strategies” by Tim Leung and Jamie Kang delves into the examination of American Depositary Receipts (ADRs) returns, with an emphasis on Asian ADRs in asynchronous markets.

By dissecting returns into intraday and overnight components relative to U.S. market hours, the study identifies the return difference between each ADR and the S&P500 index, traded via the SPDR S&P500 ETF (SPY), as a mean-reverting time series. Fitting this to an Ornstein-Uhlenbeck process through maximum-likelihood estimation (MLE) sets the foundation for developing and backtesting pairs trading strategies, which capitalize on the mean-reverting ADR-SPY spreads.

Ultimately, the research demonstrates promising results with consistent positive payouts when long positions in ADRs and short positions in SPY are executed concurrently at optimal entry and exit points, offering valuable insights for investors and traders alike.

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FAQ

Q1: What are American Depositary Receipts (ADRs), and what is the focus of the paper by Tim Leung and Jamie Kang?

ADRs are exchange-traded certificates representing shares of non-U.S. company securities. The paper by Tim Leung and Jamie Kang focuses on the dynamics of Asian ADRs, particularly in asynchronous markets, where trading occurs at different times.

Q2: How does the paper analyze the returns of ADRs, and what components are considered?

The study dissects ADR returns into intraday and overnight components concerning U.S. market hours. It identifies the return difference between each ADR and the S&P500 index (traded via SPDR S&P500 ETF) as a mean-reverting time series. This difference is then fitted to an Ornstein-Uhlenbeck process using maximum-likelihood estimation.

Q3: What key empirical observation does the study make regarding the return difference between ADRs and the S&P500 index?

The return difference between each ADR and the S&P500 index is identified as a mean-reverting time series. This observation serves as a crucial basis for further analysis and the development of trading strategies.

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