Impact of Capital Controls and Transaction Costs on the Return Distribution of Dually Traded Securities: Evidence from Chile and Argentina

In this paper we compare the distributions of ADR returns and the returns of the locally traded shares between Chile and Argentina. This comparison is interesting because both countries are emerging economies with a similar free market orientation. Both countries have similar free market orientation, but they differ in two important respects: (1) exchange rate regime and (2) restrictions to foreign investments. We find several differences between the two economies. Consistent with previous research, we find that the volatility of ADR returns tends to be higher than the return volatility of the underlying securities. We also find that the return distributions of Chilean ADRs are significantly different from the distributions of the returns on the respective underlying Chilean shares. The results reveal that while the mean returns are the same, the return standard deviations are significantly different. In contrast, Argentinean ADRs and their respective underlying shares tend to have the same distribution of returns. Finally, we employ a threshold model to estimate the transaction cost of trading the ADRs and the locally traded shares. We find that transaction costs that must be added to the returns difference before arbitrage is possible are between 1% and 2% for Chilean ADRs, and slightly lower - 0.66% to 1.65% for Argentinean ADRs. We also find that the daily return differential reversion caused by arbitrage activities is around 30% for Chilean ADRs and 40% for Argentinean ADRs.