The Overnight Return Puzzle and the 'T+1' Trading Rule in Chinese Stock Markets

32 Pages Posted: 12 Jul 2019

See all articles by Kenan Qiao

Kenan Qiao

Chinese Academy of Sciences (CAS) - Academy of Mathematics and Systems Science; University of Groningen - Faculty of Economics and Business

Lammertjan Dam

University of Groningen - Faculty of Economics and Business

Date Written: July 11, 2019

Abstract

We document a puzzling phenomenon, namely that overnight returns in Chinese stock markets are on average statistically and economically significantly negative. This finding seems to violate conventional asset pricing theory, yet the anomaly is robust to the choice of stock exchange, type of shares, and sample period, present in different market regimes (bull or bear markets), and persists across assets of small, medium, and large market capitalization. Moreover, this overnight return puzzle appears to be unique to Chinese markets. We hypothesize that a particular arrangement in Chinese stock markets explains the puzzle: the so-called "T+1" trading rule. The T+1 trading rule prohibits traders to sell shares they bought on the same the day. This asymmetric trading restriction should lead to a discount on daily opening prices. We find empirical support that the T+1 induced discount can indeed explain the overnight return puzzle, and we rule out other explanations. We estimate the average T+1 discount at 14 basis points. In addition, we establish that the T+1 discount contributes significantly to overnight risk. While the T+1 trading rule was introduced with the belief it would reduce volatility, we propose that the rule has had unintentional consequences, namely a substantial discount for opening prices and the adverse effect of increasing volatility.

Keywords: Overnight Return Puzzle, T+1 Trading Rule, T+1 Discount, Market Micro Structure

JEL Classification: G10, G12, G18

Suggested Citation

Qiao, Kenan and Dam, Lammertjan, The Overnight Return Puzzle and the 'T+1' Trading Rule in Chinese Stock Markets (July 11, 2019). Available at SSRN: https://ssrn.com/abstract=3418356 or http://dx.doi.org/10.2139/ssrn.3418356

Kenan Qiao

Chinese Academy of Sciences (CAS) - Academy of Mathematics and Systems Science ( email )

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands

Lammertjan Dam (Contact Author)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands
+31-50-3636518 (Phone)

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