Round-the-Clock Price Discovery for Cross-Listed Stocks

U.S. trading in non-U.S. stocks has grown dramatically. Round-the-clock, these stocks trade in the home market, in the U.S. market and, potentially, in both markets simultaneously. We use a state space model to study 24-hour price discovery. As opposed to the standard “variance ratio” approach, this model deals naturally with (i) simultaneous quotes in an overlap, (ii) missing observations in a non-overlap, (iii) noise due to transitory microstructure effects, and (iv) contemporaneous correlation in returns due to market-wide factors. Our findings suggest a minor role for the NYSE in price discovery for Dutch shares, in spite of its non-trivial and growing market share. The results differ significantly from the variance ratio approach. Corresponding author is Albert J. Menkveld, ajmenkveld@feweb.vu. nl, Vrije Universiteit Amsterdam, FEWEB, De Boelelaan 1105, 1081 HV Amsterdam, Netherlands, phone: +31 20 4446130, fax: +31 20 4446020, web: www.albertjmenkveld. org. Siem Jan Koopman can be reached at s.j.koopman@feweb.vu. nl; Andre Lucas at alucas@feweb.vu. nl. The authors thank Harald Hau, Marco Pagano, Maria Fabiana Penas, Neil Shephard, Laura Spierdijk, and seminar participants at the 2003 European Finance Association (EFA) conference in Scotland (Glasgow) and the 2003 SFB Workshop “Econometric Time Series Analysis: Methods and Applications” in Austria (Linz) for their comments. We gratefully acknowledge the support of Euronext in building the database. For research assistance in the early stages of the project we are grateful to Karoy Hornyak. The usual disclaimer applies. Round-the-Clock Price Discovery for Cross-Listed Stocks: U.S.-Dutch Evidence Current Version: October 13, 2003 First Version: February 27, 2003 Abstract U.S. trading in non-U.S. stocks has grown dramatically. Round-the-clock, these stocks trade in the home market, in the U.S. market and, potentially, in both markets simultaneously. We use a state space model to study 24-hour price discovery. As opposed to the standard “variance ratio” approach, this model deals naturally with (i) simultaneous quotes in an overlap, (ii) missing observations in a non-overlap, (iii) noise due to transitory microstructure effects, and (iv) contemporaneous correlation in returns due to market-wide factors. Our findings suggest a minor role for the NYSE in price discovery for Dutch shares, in spite of its non-trivial and growing market share. The results differ significantly from the variance ratio approach.U.S. trading in non-U.S. stocks has grown dramatically. Round-the-clock, these stocks trade in the home market, in the U.S. market and, potentially, in both markets simultaneously. We use a state space model to study 24-hour price discovery. As opposed to the standard “variance ratio” approach, this model deals naturally with (i) simultaneous quotes in an overlap, (ii) missing observations in a non-overlap, (iii) noise due to transitory microstructure effects, and (iv) contemporaneous correlation in returns due to market-wide factors. Our findings suggest a minor role for the NYSE in price discovery for Dutch shares, in spite of its non-trivial and growing market share. The results differ significantly from the variance ratio approach. In the last decade, international firms have increasingly sought a U.S. listing, oftentimes achieved through cross-listing their shares at either the New York Stock Exchange (NYSE) or at the NASDAQ. At the end of 2000, 420 non-U.S. firms were listed at the NYSE and generated approximately 15% of total volume that year. The NASDAQ lists even more non-U.S. firms. This trend has prompted many academic studies. Most of them focus on the benefits of cross-listings, such as reduced cost of capital and enhanced liquidity of a firm’s stock (see, e.g., Alexander, Eun, and Janakiramanan(1987, 1988), Foerster and Karolyi (1999), Karolyi (1998), Domowitz, Glen, and Madhavan (1998), Pagano, Roell, and Zechner (2002), and Miller (1999)). A relatively unexplored question is how much U.S. trading contributes to price discovery over and above domestic trading. Reasoning could go both ways. On the one hand, the home market being closest to the company’s headquarters and, therefore, closest to where information is produced, may be most important (see, e.g., Bacidore and Sofianos (2002), Hau (2001), and Solnik (1996)). On the other hand, U.S. stock exchanges being the largest and most liquid exchanges in the world may imply an important role in price discovery also for non-U.S. stocks, particularly now that their share in total U.S. volume is rapidly increasing. Chan, Hameed, and Lau (2003), for example, find that trading location matters irrespective of business location for a group of companies that changed listing from Hong Kong to Singapore. Empirical methodology for measuring contributions to price discovery