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Overnight Returns, Daytime Reversals, and Future Stock Returns Analysis

Last Updated on 10 February, 2024 by Rejaul Karim

https://www.youtube.com/watch?v=_XVib3RF9sU

In the ceaseless ebb and flow of financial markets, Ferhat Akbas, Ekkehart Boehmer, Chao Jiang, and Paul D. Koch illuminate the nuanced interplay between overnight returns, daytime reversals, and future stock returns in their forthcoming work, “Overnight Returns, Daytime Reversals, and Future Stock Returns.”

Across 73 pages, the quartet dissects the intricate dance of opposing investor forces, discerning a heightened tug of war marked by positive overnight returns followed by daytime reversals. This rhythmic seesawing hints at the presence of noise traders overnight and arbitrageurs during the day.

Importantly, the authors unveil a compelling insight: a more intense daily tug of war serves as a harbinger of higher future returns, reflecting the intricate dynamics between investor behaviors and market corrections. The study unravels the temporal symphony of heterogeneous investors and its predictive resonance for the future stock landscape.

Abstract Of Paper

A higher frequency of positive overnight returns followed by negative trading day reversals during a month suggests a more intense daily tug of war between opposing investor clienteles, who are likely composed of noise traders overnight and arbitrageurs during the day. We show that a more intense daily tug of war predicts higher future returns in the cross section. Additional tests support the conclusion that, in a more intense tug of war, daytime arbitrageurs are more likely to discount the possibility that positive news arrives overnight and thus overcorrect the persistent upward overnight price pressure.

Original paper – Download PDF

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Author

Ferhat Akbas
University of Illinois at Chicago – College of Business Administration

Ekkehart Boehmer
Singapore Management University – Lee Kong Chian School of Business

Chao Jiang
University of South Carolina – Department of Finance

Paul D. Koch
Iowa State University – Finance Department; Iowa State University – Finance Department

Conclusion

In summary, the dynamics of overnight returns and daytime reversals reveal a nuanced interplay between investor clienteles. The heightened frequency of positive overnight returns followed by negative daytime reversals within a monthly timeframe signifies an intensified struggle between noise traders in the overnight period and arbitrageurs during regular trading hours.

This pattern serves as a robust predictor of future returns across the market. The findings suggest that in periods of heightened tug-of-war dynamics, daytime arbitrageurs are prone to overcorrecting persistent upward overnight price pressure.

This intricate relationship sheds light on the intricate mechanisms at play within the stock market, where the ebb and flow of investor activity during different time intervals contribute significantly to subsequent cross-sectional returns.

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FAQ

Q1: What does the paper “Overnight Returns, Daytime Reversals, and Future Stock Returns” reveal about the interplay between overnight returns and daytime reversals?

The paper reveals that a higher frequency of positive overnight returns followed by negative daytime reversals within a month indicates a more intense daily tug of war between opposing investor clienteles. This tug of war is suggested to involve noise traders overnight and arbitrageurs during regular trading hours.

Q2: How does the intensity of the daily tug of war serve as a predictor for future stock returns, according to the study?

The study finds that a more intense daily tug of war, as reflected in the described pattern of positive overnight returns and negative daytime reversals, predicts higher future returns in the cross section. This suggests that the dynamics between noise traders and arbitrageurs during different time intervals hold predictive power for future stock market performance.

Q3: What insight does the paper provide about the behavior of daytime arbitrageurs in the context of the observed pattern?

The paper suggests that in periods of more intense tug-of-war dynamics, daytime arbitrageurs are more likely to discount the possibility that positive news arrives overnight. As a result, they may overcorrect the persistent upward overnight price pressure. This insight contributes to understanding the role of arbitrageurs in the market and their response to overnight price movements.

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