Review of Finance Advance Access published online on January 8, 2009
Review of Finance, doi:10.1093/rof/rfn031
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The Risk and Return of Arbitrage in Dual-Listed Companies*
1 Rotterdam School of Management, Erasmus University
2 Bentley University
3 Rotterdam School of Management, Erasmus University
This paper evaluates investment strategies that exploit the deviations from theoretical price parity in a sample of 12 dual-listed companies (DLCs) in the period 1980–2002. We show that simple trading rules produce abnormal returns of up to almost 10% per annum adjusted for systematic risk, transaction costs, and margin requirements. However, arbitrageurs face uncertainty about the horizon at which prices will converge and deviations from parity are very volatile. As a result, DLC arbitrage is characterized by substantial idiosyncratic return volatility and a high incidence of large negative returns, which are likely to impede arbitrage.
JEL Classification: F30, G14, G15
* We are indebted to Marco Pagano (the editor), an anonymous referee, Malcolm Baker, Dick Brealey, Greg Bylinsky, Susan Christoffersen, Ian Cooper, Bernard Dumas, Ken French, David Hirshleifer, Ben Jacobsen, Vijay Jog, Andrew Karolyi, Todd Pulvino, Cameron Rider (Allen Arthurs Robinson), Jürgen Rieg, Husayn Shahrur, Andrei Shleifer, Martin Siegel, Ronald van Dijk, Theo Vermaelen, a number of anonymous investment professionals, and the investor relations departments at various companies for helpful suggestions and discussions. We would especially like to thank Richard Royden (UBS) for his insights on DLC arbitrage. We are grateful to seminar participants at Harvard, INSEAD, Ohio State University, RSM Erasmus University, Tilburg University, University of Virginia (Darden), the 2003 Northern Finance Association Meetings in Quebec City (Canada), the 2004 European Finance Association Meetings in Maastricht (The Netherlands), and the 2004 Financial Management Association Meetings in New Orleans (LA) for insightful comments. Mathijs van Dijk is grateful for the hospitality of the Department of Finance at the Fisher College of Business (Ohio State University) where some of the work on this paper was performed. The complete collection of data, background material, graphs, and results can be obtained from http://mathijsavandijk.com/.