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Small Trades and ADR Premiums : The Case of Indian ADRs

There is a growing literature on the impact of small trades/retail investors on stock prices, with some studies suggesting that strong buying by retail investors leads to overvaluation of stocks. We examine the impact of small trades in the U.S. on Indian ADR prices relative to the underlying stock. These ADRs trade at significant premiums that cannot be arbitraged due to Indian government regulations. The existence of two market prices for claims to the same set of underlying cash flows closely resembles the closed-end fund (CEF) discount puzzle. In the case of ADRs, we can rule out the tax, and agency cost explanations. Hence, Indian ADRs provide a better setting to examine the evidence for investor sentiment influencing market prices. Consistent with such an influence, we find that ADR premiums are positively related to orderimbalance of small ADR trades. The premiums associated with the small trades are reversed in two weeks. We control for price pressure effects by including order-imbalance of all trades. Also, premiums are negatively related to the volatility implied by S&P500 index option prices (VIX).