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  Paulo Pasquariello

Companies Show Clever Currency Moves

4/16/2010 --

A study of ADR issues reveals evidence that certain companies know how to predict swings in the currency market.

ANN ARBOR, Mich. — There's always been a bit of a mystery in the currency markets as to whether it's possible to predict price changes. Unlike stocks and bonds, currencies generally move on macroeconomic — not company-specific — issues. That should make it hard for someone to have inside knowledge and profit from it.

However, it's long been suspected that some companies are able to do just that. Because company-level currency transactions are private, trading data is unavailable for study. But Ross professor Paolo Pasquariello found evidence that certain types of companies can time the currency markets to their advantage when he examined American Depository Receipts (ADRs) issued in the United States by foreign firms. ADRs are one of the primary vehicles foreign firms use to sell shares in the United States. Pasquariello's paper "Is There Timing Ability in the Currency Markets? Evidence from ADR Issuances" shows companies from emerging markets, companies with higher currency exposure (because of their export activity), and manufacturing companies seem expert at timing the currency market to their advantage, according to when they issued their ADRs.

"We only suspected that companies might have information about currency markets that others don't have, but we didn't have any direct evidence," says Pasquariello, assistant professor of finance. "It turns out they do. When they issue ADRs as a way to raise capital, currency matters. This study shows there are companies engaged in activities that have nothing to do with speculating in the currency market that have the ability to predict exchange rates."

This expertise can be quite profitable. Timing ADR issues advantageously to exchange rates resulted in additional proceeds of $646 million, or 1.8 percent, of the total capital raised from ADRs, over a one-year period.

This study — by showing that companies involved in global trade likely are savvy players in the currency markets — may help explain why currency trading can make prices move persistently. For currency traders, that's valuable information on who is moving the market.

"If you play in the market, it's worth knowing who is in the know," Pasquariello says. "Don't treat these companies as ignorant."

Money Talks

It's been known for some time that when a company decides to issue an ADR, it times the stock market to its advantage. The question was whether anyone could detect an ability to time the currency markets at the same time.

Pasquariello and his co-author Qiaoqiao Zhu (a former PhD student at the University of Michigan, currently at Queensland University in Australia) attacked it from a couple of angles. One was an econometric model that controlled for stock market timing. This approach showed companies set the dates for ADR issues when the exchange rate between their local currency and the dollar was the most favorable to maximize the proceeds of the issue, both in U.S. dollars and their local currency.

The authors also looked at two different types of ADRs: Level Two and Level Three. A Level Two ADR doesn't raise capital for the issuing company, but allows its shares to be traded on a U.S. exchange, raising its market visibility. Level Three ADRs are more like an initial public offering and raise capital for the issuing firm.

Pasquariello and Zhu found no currency market timing with Level Two ADRs, but strong evidence of currency market timing with Level Three, when the company stood to profit.

"First, that tells us there was no bias in our procedure, that we weren't finding market timing when it wasn't there," he says. "Second, we found the timing exactly when you would expect to find it — when money matters. To me, that's the crucial piece of evidence in this paper."

A deeper dive into the results helps explain the ability to time currency markets. Companies with significant export activity deal with foreign currencies daily. This means it's likely there are specialists at these companies who have developed an expertise for understanding currency markets.

Companies from emerging markets also display a higher aptitude to correctly time the currency markets when planning their ADR issues. Pasquariello says this also makes sense, since a large company in a smaller country represents a bigger slice of that nation's economy than is typical in a more developed country. That kind of advantage offers better knowledge of the local government and central bank, which makes decisions affecting the currency.

Lastly, companies show a higher ability to time the currency markets amid times of financial turmoil. During financial crises, currency values can swing wildly, and a savvy person can take advantage of mispricing.

"There's always the question when it comes to currency exchange of how you can get inside knowledge," Pasquariello says. "We show evidence that some companies do, and can make good conjectures on why, by looking at the types of companies that have this timing ability."

—Terry Kosdrosky

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847,