Dispersion of Opinions, Limits to Arbitrage, and Overnight Returns

Abstract

Using nine years of intraday data for the largest 3,000 U.S. stocks, we find a strong tendency for positive returns during the overnight period followed by reversals during the subsequent trading day. This behavior is driven by an opening price that is high relative to intraday prices. Consistent with the theory of Miller (1977) and other disagreement models, we find this behavior is limited to stocks with high dispersion of opinions measured near the daily open, as well as over the entire trading day. Furthermore, the magnitude of these overnight returns and trading day reversals is progressively greater among finer subsamples of stocks subject to greater limits to arbitrage, embodied in more binding short sale constraints and high transaction costs.

Keywords: market efficiency, limits to arbitrage, short sale restrictions, institutional ownership, transaction costs, dispersion of opinions, disagreement, overpricing

JEL Classification: D82, G14, G19