Working Paper: CEPR ID: DP14462
Authors: Nina Boyarchenko; Lars C. Larsen; Paul Whelan
Abstract: Since the advent of electronic trading in the mid 1990's, U.S. equities have traded (almost) 24 hours a day through equity index futures. This allows new information to be incorporated continuously into asset prices, yet, we show that almost 100% of the U.S equity premium is earned during a 1-hour window between 2:00 a.m. and 3:00 a.m. (ET) which we dub the "overnight drift". We study explanations for this finding within a framework a la Grossman and Miller (1988) and derive testable predictions linking dealer inventory shocks to high-frequency return predictability. Consistent with the predictions of the model, we document a strong negative relationship between end of day order imbalance, arising from market sell offs, and the overnight drift occurring at the opening of European financial markets. Further, we show that in recent years dealers have increasingly offloaded inventory shocks at the opening of Asian markets and exploit a natural experiment based on daylight savings time to show that Asian offloading shifts by one hour between summer and winter.
Keywords: Equity Risk; Overnight Returns; Intraday Immediacy; Inventory Management
JEL Codes: G13; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dealer inventory shocks (L81) | return predictability (C53) |
| closing order imbalance (C69) | intraday returns (G14) |
| market sell-offs (G10) | overnight drift (Y60) |
| dealer behavior (L14) | market returns (G19) |
| closing order imbalance (C69) | subsequent returns (I26) |
| daylight savings time (C41) | timing of overnight drift (C41) |