Return Spread and Liquidity on Chinese ADRs

We empirically investigate the role of host (U.S.) and home (Hong Kong) (HK) security market returns as common determinants of security returns for Chinese American Depository Receipts (ADRs) and their underlying H-shares. We also empirically determine the relation between return spread (difference between the returns on ADR and the corresponding underlying security) and security specific liquidity for ADRs and their underlying HK shares after controlling for U.S. and Hong Kong market returns. We use multiple proxies for liquidity and find evidence that trading volume and liquidity spread (the difference between trading volumes) for ADRs and their underlying HK securities are consistent determinant of return spread for Chinese ADRs with primary listing in Hong Kong stock exchange (SEHK). We use a switching regression model and find the model parameter estimates are not stationary and change over three distinct time periods, before 2000, 2000-2003, and after 2003.