Price Discovery in International Equity Trading

This study addresses two questions: where does price discovery occur for internationally-traded firms and how do international stock prices adjust to an exchange rate shock? These questions are answered by analyzing quotes originating in New York and Frankfurt for three large German firms, DaimlerChrysler, Deutsche Telekom, and SAP, during overlapping trading hours. A high-frequency sample of quotes from both locations along with the dollar/euro exchange rate yields evidence of one cointegrating relation among the 3 variables. Vector error correction models are estimated for each firm and the associated vector moving average representations are utilized to infer the share of price discovery coming from the exchange rate, New York, and Frankfurt quotes. The evidence suggests a structure of the international equity market that has the home-market largely determining the random walk component of the international value of a firm along with an independent role for exchange rate shocks to affect prices in the U.S. markets. However, there is a significant information share for New York in the case of DaimlerChrysler and an even bigger role for New York with respect to SAP. Following a shock to the exchange rate, we find that almost all of the adjustment comes through the New York price.