What is Linkage
Linkage is the ability to buy a security on one financial exchange and sell that same security on another exchange. Certain depositary receipts, such as American Depositary Receipts (ADRs) allow for linkage, which means that an investor can purchase shares of a company on a foreign exchange, such as the Toronto Stock Exchange, and then sell those shares on a domestic exchange, such as the New York Stock Exchange. ADRs allow investors around the world to buy and sell large international companies' stock. Because a security’s price may be different on various exchanges, an investor might profit by selling the stock for a higher price than for which he bought it, thus creating an arbitrage opportunity.
Breaking Down Linkage
Linkage can mean buying a security on one exchange and selling it on another exchange. (Note, however, that linkage is different from the concept of a dual listing on two exchanges.) Often, when investors engage in linkage, as we mean it here, they are in fact seeking an arbitrage situation—profiting from the same stock’s price differential on different exchanges. Arbitrage generally promotes healthy competition among the various exchanges, and this type of linkage has become easier with the advent of electronic exchanges and trading platforms.
Two other examples of this type of linkage come to mind. The first is in the Bitcoin (BTC) economy, where arbitrage serves an important function. In BTC trading, individual traders, as well as automated bots, actively scan for price differences between the various Bitcoin exchanges, then buy from one and sell to another exchange if the price disparity ever becomes high enough for the transaction to be profitable.
The second example occurs in the microfinance space. Here, “linkages” between established (or formal) financial services institutions and less formal (or informal) financial systems combine to provide financial help to the poor. Formal financial institutions have extensive infrastructures, systems, and access to funds; they are usually far removed from rural or poor clients, which makes it difficult to obtain adequate information and reduce risks. In contrast, informal financial institutions operate close to rural clients, possess quite good information and enforcement abilities; and typically are more flexible and innovative than formal institutions. The strengths of one compliment the weaknesses of the other, which enables the linked institutions to offer millions of very poor people the opportunity to receive and repay small loans, even though they possess few actual assets or skills.