Return Extrapolation and Day/Night Effects
57 Pages Posted: 9 Aug 2022
Date Written: August 4, 2022
We propose that differences between overnight and daytime returns are the result of return extrapolation. After high daytime returns, morning order imbalances are high in the first 15 minutes of regular trading the next day, which is consistent with higher overnight returns. The effect is asymmetric, with positive returns having larger response than negative returns, and it is stronger in more overpriced stocks and stocks with more retail interest. At the portfolio level, extrapolative effects can explain most of the cross-sectional variation in the "tug of war" between overnight and daytime returns. Extrapolative trading is also consistent with the upward sloping relation between market beta and average overnight returns.
Keywords: extrapolation, overnight returns
JEL Classification: G12
Suggested Citation: Suggested Citation