Asymmetric Arbitrage Opportunities for Cross-Listed Stocks: Evidence from Russia

ABSTRACT

We study alternative arbitrage strategies for stocks of Russian companies and the corresponding depositary receipts issued in European exchanges (‘mirror trades’). We provide evidence for significant arbitrage opportunities in Russia, and the potential returns are higher when the depository receipts are underpriced relative to stocks on the domestic market. Such asymmetry in arbitrage returns may be a consequence of money expatriation from Russia using these ‘mirror trades’ even when they are unprofitable, creating further mispricing. We also show that the long-short ‘buy-and-hold’ strategies, although being risky, generate returns which are about twice as high as the returns to the conversion strategies. Although the arbitrage returns have declined over time, they are still positive and generally higher than the market returns. Low liquidity of Russian depositary receipts on European exchanges is a significant barrier to arbitrage.

KEY WORDS:

• arbitrage
• cross-listed stocks
• depositary receipts
• emerging markets
• market efficiency

JEL:

• G14
• G15

Acknowledgments

We are very grateful to Andrei Simonov, Edouard Inozemtsev, Bekhan Chokaev, Vadim Zyamalov and other seminar participants at Gaidar Institute for Economic Policy, Higher School of Economics, EFMA and WFC meetings, and an anonymous referee for their helpful comments and suggestions. The article also benefited from discussions with several traders in the Russian stock market. We highly appreciate the hospitality of Gaidar Institute for Economic Policy where this research was conducted.

Notes

1. This risk is not related to the company fundamentals, but rather a result of investor sentiment, market microstructure issues or noise traders (e.g. Scruggs 2007).

2. A similar conversion strategy is also available for ETFs, and several studies evaluate such arbitrage opportunities (e.g. Cherry 2004; Marshall, Nguyen, and Visaltanachoti 2013).

3. For expositional simplicity, we assume that the conversion coefficient is 1, that is one depositary receipt can be converted into one stock and vice versa.

4. The exchange commissions are reported on the exchanges’ web-sites: micex.ru, deutsche-boerse.com, londonstockexchange.com. The Russian brokers’ commissions are collected from web-sites www.finam.ru/services/CommissionRates and sberbank.ru/ru/person/investments/broker_service/tariffsanddocuments/tariffs. Whenever a range of tariffs exists, we always assume the maximum tariff, so that our return estimates are the most conservative.

5. Detailed description of short sales and the associated costs can be found in Jones and Lamont (2002) and D’Avolio (2002).

6. It should be noticed that it is usually possible to borrow a security for a short period of time, and there is a risk that it will be costly to borrow it again later. But in case of the direct arbitrage this risk can be neglected because it usually takes no more than 5 trading days to convert one security into another and return the borrowed security.

7. This value of the transaction costs is reported on the web-site of the Russian exchange http://moex.com/s206.

8. Our lower bound of transaction costs almost coincides with the upper bound given in Ghadhab and Hellara (2015) for the UK and Germany markets (70.68 bp).

9. See Gagnon and Andrew Karolyi (2010), Alsayed and McGroarty (2012), Ghadhab and Hellara (2015).

10. Again, we should point out that since daily closing prices on different exchanges are not completely simultaneous, we cannot interpret the returns obtained as actual arbitrage returns, but rather as a proxy for them.

11. We assume that all transaction costs are paid immediately when a position is opened. This is the most conservative assumption.

12. This situation is not hypothetical. One of the recent examples is the case of Sberbank in the beginning of 2013 (http://www.vedomosti.ru/finance/news/8635091/sberbanka_na_vseh_ne_hvatit).

13. This list is available on the web-site of MICEX, and the historical data is available at http://www.micex.ru/markets/stock/disclosure.

14. Using closing prices might lead to a biased result since the closing times are different for the Russian and European exchanges. The bias may arise due to the fact that the market rises, on average, and thus the European closing prices (prices of receipts) could be, on average, higher than the Russian closing prices (prices of stocks). However, this bias goes in the opposite direction with our result: for most of the pairs, stocks are more expensive than the corresponding receipts. Thus, our results could only be stronger without this potential bias.

15. Even though we may open an arbitrage position every day, it takes about five days to convert one security into the other and close the position. Therefore, we interpret the return to one arbitrage position as a five-day return.

16. The net returns expressed in rouble terms are always similar and are not reported.

17. The respective rouble returns are insignificantly higher and are not reported.

18. 30 million roubles is the size of a position that we assume to calculate the price impact.