South Korea: ADR Pairs Trade
Hedging involves the simultaneous purchase of one security and sale of another, because the first is relatively cheaper than the second. Where the security bought sells at a lower price than the one sold, there must be good reason for believing that the price of the two will come closer together,—and conversely for the opposite circumstance.
Oftentimes there are wide price differences between American Depository Receipts and their underlying stocks listed internationally. In fact, a simple relative value hedging method has produced returns of over 30% per annum:
http://www.bauer.uh.edu/rsusmel/Academic/ptadr.pdf
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“Since some Asian markets have short-selling restrictions, the ‘pairs trading’ strategy is restricted to buying the underlying shares and selling the ADRs.” Does South Korea prohibit short selling?
How does one go about buying South Korean securities?
The KRX requires short sellers to open a margin account with at least KRW 1 million, or roughly US $800. Typically, Korean broker dealers establish their own minimum threshold in excess of this requirement. For instance, Coutts requires US $500,000 in equity.
The high number of relative value arbitrage opportunities suggests that short selling, let alone outright arbitrage, is not very popular in Korea. It is an open and exciting field.