Are tugs of war agreeable? Evidence from aggregate stock returns

Abstract

This study reveals that the tug of war between overnight noise traders and daytime arbitrageurs, as evidenced by the aggregation of the monthly average of positive overnight returns followed by negative daytime reversals across firms, significantly predicts future market returns in both the U.S. and CHN markets, both in-sample and out-of-sample. Consistent with the theory in Akbas et al. (2022), in a dynamic market (U.S. market), daytime arbitrageurs tend to overcorrect to positive overnight price pressure, especially during periods of significant mispricing, which may overlook positive macroeconomic news, and good cash flow news. Conversely, in a static market (CHN market), daytime arbitrageurs tend to remain on the sidelines due to T+1 trading regulations and short-selling constraints, especially during periods of pessimistic sentiment.

Keywords: Heterogeneous investors, Tug of war, Dynamic and static market, Return predictability