Cycles of Declines and Reversals following Overnight Market Declines

40 Pages Posted: 2 Dec 2018 Last revised: 8 Feb 2019

See all articles by Farshid Abdi

Farshid Abdi

University of Saint Gallen, School of Finance; New York University, Stern School of Business

Date Written: September 2018

Abstract

This paper uncovers and explains the emergence of cycles of intraday declines and overnight reversals in the U.S. stock market in the 21st century. Using quote midpoints for the past 24 years of common stocks traded in the three main exchanges, I show that the cross-sectional association between average intraday and overnight returns has steadily shifted from a direct association into a strong inverse association over the years. I explain this shift by showing that after 2001, consistent with theoretical models in which binding capital constraints lead to liquidity dry-ups, an overnight decline in the stock market is followed by a further intraday decline for volatile stocks and their reversal over the next overnight period. Moreover, I show that market liquidity of volatile stocks further deteriorates following an overnight market decline, which confirms my proposed explanation. Finally, I show that idiosyncratic volatility, compared with systematic risk, better explains the cross section of the documented systematic intraday declines and overnight reversals.

Keywords: Market Liquidity, Funding Liquidity, Reversals, Effective Spread, TAQ

JEL Classification: G10, G12, G15, G20

Suggested Citation

Abdi, Farshid, Cycles of Declines and Reversals following Overnight Market Declines (September 2018). University of St.Gallen, School of Finance Research Paper No. 2018/29; NYU Stern School of Business. Available at SSRN: https://ssrn.com/abstract=3287680 or http://dx.doi.org/10.2139/ssrn.3287680

Farshid Abdi (Contact Author)

University of Saint Gallen, School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

New York University, Stern School of Business ( email )

44 West 4th Street
Suite 9-195D
New York, NY NY 10012
United States

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