Asynchronous ADRs: Overnight vs Intraday Returns and Trading Strategies

TL;DR

This paper analyzes the overnight and intraday returns of Asian ADRs, models their mean-reverting spreads with the Ornstein-Uhlenbeck process, and develops profitable pairs trading strategies exploiting these dynamics.

Contribution

It introduces a novel empirical analysis of ADR returns, models their spreads as mean-reverting processes, and designs effective pairs trading strategies based on these insights.

Findings

ADR-SPY spread is mean-reverting and fits an Ornstein-Uhlenbeck process.

Pairs trading strategies yield consistent positive returns.

Intraday and overnight return components differ significantly.

Abstract

American Depositary Receipts (ADRs) are exchange-traded certificates that rep- resent 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 asyn- chronous markets, we present methodologies and results of empirical analysis of their returns. In particular, we dissect their returns into intraday and overnight com- ponents 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 payoffs when long position in ADR and short position in SPY are simultaneously executed at selected entry and exit levels.