Overnight returns, daytime reversals, and future stock returns

Overnight returns of industry exchange‐traded funds, investor sentiment, and futures market returns

“…Whereas prior work establishes that investor heterogeneity has significant implications for asset prices (e.g., Aboody et al, 2018;Berkman et al, 2012;Gârleanu & Panageas, 2015;Harrison & Kreps, 1978;Lou et al, 2019), Akbas et al (2021) propose a new indicator calculated from the intensity of the daily tug of war between overnight and trading day clienteles to explore whether this daily tug of war induced by investor heterogeneity influences the cross-section of subsequent stock returns. They show that a more intense daily tug of war predicts higher future returns in the crosssection, indicating that return predictability can be explained by the overcorrection hypothesis.…”

“…Second, the return predictability among stocks in the long leg of the trading strategy is better than that in the short leg. Third, Akbas et al (2021) conduct a placebo test in which they analyze the alternative sequence of daily reversals that proceed from a negative daytime return to a positive overnight reversal, rather than the other way around. As expected, the results of the placebo test reveal no predictive power behind these daytime-to-overnight positive reversals.…”

“…If Hypotheses 1-3 hold, investor sentiment measures constructed from overnight returns of industry ETFs might be suitable for predicting index futures returns. As indicated by Akbas et al (2021), overnight retail traders are not always irrational investors. Specifically, some component of repeated overnight price pressure induced by optimistic overnight retail traders tends to be based on superior information relative to the behavior of daytime arbitrageurs.…”

“…Lachance (2021) shows that unusually high overnight returns of ETFs are distorted by market microstructure effects. However, as suggested by Lou et al (2019) and Akbas et al (2021), high overnight returns can be explained by the fact that heterogeneous investor clienteles tend to initiate trades at different points in a day. Following Lou et al (2019) and Akbas et al (2021), our evidence shows that high overnight returns of industry ETFs are associated with optimistic overnight retail traders.…”

“…relative to the rest of the trading day. Specifically, the overcorrection hypothesis proposed by Akbas et al (2021) states that persistent daily reversals with high opening prices are associated with optimistic overnight retail traders and daytime arbitrageurs to overcorrect a prolonged sequence of positive overnight returns. In a similar vein, overnight returns of industry ETFs might be correlated with the industry demand of optimistic overnight individual/retail investors for two main reasons.…”