Banking Sector Strength and the Volatility of Cross-Listed Securities

Abstract

This paper tests the effect of banking sector strength on the volatility of American depository receipts (ADRs) listed on major U.S. exchanges. Prior research suggests that when banking systems are fragile, financial capital markets experience higher volatility. In this paper, we examine whether firms operating in countries with more stable banking systems experience less volatile equity prices.

Using panel regressions based on a broad dataset of ADRs from 43 countries, we analyze whether cross-listed securities from more solid banking systems are associated with a lower degree of volatility. Using our ADR-year panel dataset, we apply OLS regressions to study how the following country-level variables affect ADR volatility: Bank Capital/Total Assets, Bank Deposits/GDP, Bank Z Score, and Central Bank Assets/GDP.

Our results confirm that there is such a relationship, with the deposits/GDP ratio of the home country, in particular, playing a central role in alleviating ADRs’ volatility. This calming effect holds for different measures of volatility and under different regression specifications and control variables.

Our results suggest that countries with more stable banking sectors are likely to enjoy lower levels of stock price volatility for banking entities. This paper provides new insights for both academics and practitioners dealing with the stability of asset prices, and may also be of interest to regulators, banking supervisors, and central banks seeking to preserve and promote the stability of both the banking and capital markets systems.