The Effect of Foreign Ownership Restrictions on the Price Dynamics of Depositary Receipts–Evidence from the Taiwan and Hong Kong Markets

In this paper, we study depositary receipt prices in regulated markets and free-entry markets. Because of their unique environments, the Taiwanese and Hong Kong markets provide interesting settings that have not yet been explored in the literature. In particular, we focus on the following: (1) the difference in the long-term price relationships between depositary receipts and underlying securities in free-entry and regulated areas, (2) the price dynamics of the depositary receipts for firms with and without the long-term equilibrium relationships between depositary receipts and underlying securities, and (3) the incremental information content of the qualified foreign institutional investor (QFII) ownership ratio for the depositary receipts issued by Taiwanese firms. The empirical results reveal that long-term equilibrium relationships between depositary receipts and underlying security prices exist for firms listed in Hong Kong, a free-entry market, but do not necessarily exist for firms listed in Taiwan with foreign ownership restrictions. The long-term equilibrium relationships between depositary receipts and underlying securities and the local market conditions are the most important factors in explaining the depositary receipt returns when the equilibrium exists. In the absence of equilibrium, the lagged returns of depositary receipts or underlying securities and the local market conditions become important. In addition, QFII ownership ratios significantly explain the depositary receipt price variations in a regulated market, which implies the restriction effect on the price dynamics of the depositary receipts.