Understanding the ADR Premium under Market Segmentation

Understanding the ADR premium under market segmentation by Matthieu Stigler, Ajay Shah and Ila Patnaik.



The abstract reads: Capital controls can induce large and persistent deviations from the Law of One Price for cross-listed stocks in international capital markets. A considerable literature has explored firm-specific factors which influence ADR pricing when LOP is violated. In this paper, we examine the interlinkages between Indian ADR premiums and macro economic time-series. We construct an ADR premium index, whereby diversification across firms diminishes idiosyncratic fluctuations associated with each security. We find that the S&P 500 index and the domestic Nifty index influence the ADR Premium Index. Positive shocks to the ADR premium index precede higher purchases by foreign investors on the domestic market, and precede positive returns on the domestic index.

Many practitioners in India believe that net FII flows matter greatly to stock market returns. But this belief is not borne out when you carefully look at the evidence. The VAR in the above paper says this one more time: in the context of the specification used in this paper (aimed at uncovering insight into a different issue, the ADR Premium) you don't see an impact of a rise in net FII flows upon stock prices.

On an interesting story about the ADR Premium for one stock (as opposed to macroeconomic thinking), see: Spike in the ADR Premium on Tata Motors by Anmol Sethy.

You might like to see: the stock of papers from the NIPFP Macro/Finance Group.

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Two papers on monetary policy

Monetary
policy in an uncertain world: Probability models and the design of
robust monetary rules by Paul Levine.

The abstract reads: The past forty years or so has seen a
remarkable transformation in macro-models used by central banks,
policymakers and forecasting bodies. This paper describes this
transformation from reduced-form behavioural equations estimated
separately, through contemporary micro-founded dynamic stochastic
general equilibrium (DSGE) models estimated by systems methods. In
particular by treating DSGE models estimated by
Bayesian-Maximum-Likelihood methods I argue that they can be
considered as probability models in the sense described by Sims
(2007) and be used for risk-assessment and policy design. This is
true for any one model, but with a range of models on offer it is
also possible to design interest rate rules that are simple and
robust across the rival models and across the distribution of
parameter estimates for each of these rivals as in Levine et
al. (2008). After making models better in a number of important
dimensions, a possible road ahead is to consider rival models as
being distinguished by the model of expectations. This would avoid
becoming `a prisoner of a single system' at least with respect to
expectations formation where, as I argue, there is relatively less
consensus on the appropriate modelling strategy.

A
Floating versus Managed Exchange Rate Regime in a DSGE Model of
India by Nicoletta Batini, Vasco Gabriel, Paul Levine
and Joseph Pearlman.

The abstract reads: We first develop a two-bloc model of an
emerging open economy interacting with the rest of the world
calibrated using Indian and US data. The model features a
financial accelerator and is suitable for examining the effects
of financial stress on the real economy. Three variants of the
model are highlighted with increasing degrees of financial
frictions. The model is used to compare two monetary interest
rate regimes: domestic Inflation targeting with a floating
exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both
rules are characterized as a Taylor-type interest rate rules. MEX
involves a nominal exchange rate target in the rule and a
constraint on its volatility. We find that the imposition of a
low exchange rate volatility is only achieved at a significant
welfare loss if the policymaker is restricted to a simple
domestic inflation plus exchange rate targeting rule. If on the
other hand the policymaker can implement a complex optimal rule
then an almost fixed exchange rate can be achieved at a
relatively small welfare cost. This finding suggests that future
research should examine alternative simple rules that mimic the
fully optimal rule more closely.

You might like to
see: the
stock of papers from the NIPFP Macro/Finance Group.

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Interesting readings

Two striking stories in India's crisis of
governance: Sadanand
Dhume in the Wall Street Journal on the Commonwealth
Games,
and Nilanjana
S. Roy in the New York Times on the personal safety of women.

The deep determinants of the problems of India's economy lie in the
political system, and the deep determinants of the problems of
Indian politics lie in the way elections work. One of the many
blunders of our Constitution was the use of first-past-the-post in
elections. See Anthony
Gottlieb in the New Yorker magazine.

Ila Patnaik has four recent
pieces: Capital
controls and unhedged currency exposure on the
new India Policy Forum
website; The
Mauritius code (in the Indian Express) on a fresh
approach to thinking about the Mauritius
treaty; concerns
about inflation in the Financial Express and a piece
on inflation
targeting aimed at the white paper readership of
the Indian Express.

A while ago, paypal had figured in my list of things that
were banned
in India. They have announced a workaround : for payments made
to customers in India, they will use snailmail
and send
out a cheque. And so the 20th century payments innovation will
be reduced to a 19th century solution.

The
frontiers of Nifty, by Ashish Rukhaiyar in the Business Standard.

Mahesh
Vyas in Financial Express about criticism of SEBI.

Devika
Banerji in the Business Standard about the changing
world of the economics think tanks.

Bibek
Debroy in the Financial Express on the rupee's new symbol.

Didi
Kirsten Tatlow on the struggle to remember, in China. Also
see America
and China in 2020 by Ian Bremmer.

Jayanth
Varma has a chapter in a Robert Kolb book.

I wrote a comment on the `Economics | by invitation' system run
by The Economist, on their
question: What
will it take to convince emerging markets to halt reserve
growth?.

Dream-logic,
the Internet and artificial thought by David Gelernter,
on Edge.

Protests
have broken out in France against the government's ban on the `burkha'.

A while
ago, I
had argued that world food price vol had risen and would rise
further. It looks like the evidence is in favour of that
proposition. See: What
explains the rise in food price volatility? by Shaun
K. Roache.

A great
piece in
the Economist about Europe's future.

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Learning about inflation from a box of eggs

Milan Kumar Biswas, General Manager of Keggfarms Pvt. Ltd. knows something about inflation. In a note addressed to his customers, stuffed in a box of eggs, he announced an increase in the unit price of his eggs.



P = (1+markup) MC. To justify the change in P, of course not due to his own greed (the "markup"), Mr. Kumar blames various "exogenous" factors for the price increase, all bunched in what economists call "marginal cost". He tells us about the components of his marginal cost:

1. Input costs for feed: read food grains and other food items.
   
   


2. Man-power: read wages.
   
   


3. Packaging and transportation costs: read a mixture of wages, services and fuel prices.

This points to something more than just food inflation. Mr Kumar, just like our RBI Governor, seems to suggest that price pressures are indeed quite generalised.



On 1), we knew about food inflation from the the WPI and the CPI. What is novel is the information on the pass-through to processed food items from unprocessed ones. It is a clear example of the cascading effects of input costs into prices downstream from the production chain.



On 2), unfortunately we have no direct and timely statistical evidence about wages in India. Hence, we, alongside our Central Bank, are left grasping for evidence from anecdotal and piecemeal information. If true, it would be indeed bad news. A input cost increase passed onto wages, i.e. the famous "second round effects". This puts us into something like that classic story of mishandled inflation, the oil shock of the 1970s.



On 3), we unfortunately have no clue what are the developments in services prices. Hopefully CSO will soon release a new CPI so we can start seeing some of this.



Last, but not the least, can we also trust Mr. Kumar that he will not raise his markup in a period of ongoing recovery of demand? Economists have long disagreed on this question. See the seminal papers by Rotemberg and Woodford, and, more recently, Ramey and Nekarda.

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Implementing the GST

For many years, India has been in a slow processes of evolving towards a dual centre-state GST. The rough picture is one with two distinct but harmonised taxes, which have an integrated IT system so as to sharply reduce compliance costs. A key dimension is that of properly integrating domestic taxation with international trade in goods and services, by zero-rating exports (thus exempting non-residents) and by charging the GST upon imports (thus taxing the full consumption of residents).



This process has faced two challenges: politics and administration. On the political side, the puzzle lies in having enough states sign up into a system where all taxes other than the GST are abolished, and where firms face an integrated nationwide administration. This would enable a unified Indian common market. Things seem to be going badly on that front.



The administrative challenge is one of project management. The Indian policy landscape contains many important ideas where the political hurdles have been crossed, but where execution has been lacking.

Today there is news of a concete project management strategy for the GST: see this story by Surabhi Agarwal in the Mint. So while there might be many failures on the political side of the GST, atleast we now know that there will be some coherent project management which will yield a working GST system within a year or two.



The idea of bringing NSDL into this problem is not new. Ever since the Tax Information Network (TIN) was built by NSDL for the income tax department, it was well understood that handling of VAT credits is much like handling of TDS. In 2004, the Task Force on Implementation of the FRBM Act, chaired by Vijay Kelkar, had said in the executive summary: ``Hence, the Task Force recommends that the existing TIN and OLTAS systems, developed by CBDT, should be used for the implementation of the GST, both at the Centre and at States.'' We wasted a lot of time in getting to this destination, but while the wheels grind slow, they have ground true. When NSE and NSDL came about in the early 1990s, we had little idea about the far-reaching consequences of what was coming together.



Also see: M. Govinda Rao in the Business Standard.

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The push for atleast 25% outside shareholding

The Indian authorities are in the process of pushing listed
companies to have atleast 25% shareholding with outside shareholders.
I wrote a column in the Financial Express,
titled Outside
shareholding and market liquidity: Indian empirical
regularities where I look at how size and outside shareholding
come together to matter for stock market liquidity.

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Post offices and financial inclusion

An expert committee report: Harnessing the India Post network for financial inclusion has been released. This is a joint effort between Department of Post, Department of Financial Services, Department of Economic Affairs and Invest India Economic Foundation. It has some interesting new ideas on the unique role of post offices in financial inclusion, and the way to best harness these strengths while retaining a useful sense of the public/private divide.



Also see:

• Souvik Sanyal in the Economic Times, 29 July 2010.


• Stamps, savings, microloans and more, on the IFMR blog, 10 August 2010.


• Post offices can bring in financial inclusion, by Sanjeev Kumar Patro in the Indian Express, 3 August 2010.


• Irda’s plan to sell insurance products through post offices hits roadblock by Remya Nair and Surabhi Agarwal, in Mint, 28 February 2011.
  
  

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