Do naive investors, lured by news they encounter while the stock market is closed, bid up the prices of attention-getting stocks at the open? In their June 2010 paper entitled “Paying Attention: Overnight Returns and the Hidden Cost of Buying at the Open”, Henk Berkman, Paul Koch, Laura Tuttle and Ying Zhang examine whether attention-based trading by individual equity investors reliably causes temporary mispricing at the market open. Using intraday bid and ask price data for the 3,000 largest U.S. stocks over the period 1996-2008 (13 years), along with contemporaneous measures of retail investor attention to individual stocks and overall market sentiment, they conclude that:
- Returns across all stocks in the sample tend to advance overnight (0.1% per night) and reverse during the trading day (-0.07% per day).
- The overnight price bump derives mostly from high levels of retail buying at the open among stocks that have recently attracted the attention of individual investors. A subsample of stocks with high retail attention and low institutional ownership has an average overnight return (trading day reversal) in the range 0.2% to 0.3% (-0.2% to -0.4%). This attention effect tends to persist across days.
- The overnight price bump is pronounced for stocks that are difficult to value and costly to arbitrage (illiquid, high short interest). A subsample of such stocks has an average overnight return (trading day reversal) in the range 0.4% to 0.6% (-0.4% to -0.7%).
- Average overnight return and trading day reversal are more than twice as large during months with high versus low aggregate investor sentiment.
- The overnight/trading day pattern holds for all styles of stocks, is somewhat stronger on Mondays, and weakens following decimalization in 2001 and expansion of algorithmic trading in 2005.
The following chart, taken from the paper, plots the average ratio of the midquote at various times during the trading day to the closing midquote for all stocks over the entire sample period. Measurements occur at 5-minute intervals over the first and last half hours of the trading day, and at 30-minute intervals over the rest of the trading day. The degree to which these Intraday Price Ratios fall outside the upper and lower 95% confidence intervals (constructed using the standard error of the time series mean across all days) indicates the statistical strength of the mispricing effect.
The chart shows that mispricing is statistically strong during about the first hour of the trading day.
In summary, evidence from a fairly large recent sample of U.S. stocks indicates that traders may be able to suppress trading friction by systematically executing sales at the open and buys later in the trading day.
Frequently Asked Questions
What is the overnight return effect in stocks?
The overnight return effect is the tendency of stock prices to rise between the prior close and the next open, then reverse during the trading day. In a 1996-2008 sample of the 3,000 largest U.S. stocks, returns averaged 0.1% overnight and reversed by -0.07% intraday. The pattern is linked to attention-based buying by individual investors at the open.
Does retail investor attention cause stock prices to be temporarily inflated at the market open?
Retail investor attention does appear to cause temporary overpricing at the open, mostly among stocks that recently attracted individual investors' attention. Stocks with high retail attention and low institutional ownership had average overnight returns of 0.2% to 0.3% and trading day reversals of -0.2% to -0.4% (1996-2008). The effect tends to persist across days and is statistically strong mainly during roughly the first hour of trading.
How is mispricing at the market open measured using intraday prices?
Mispricing at the open is measured with Intraday Price Ratios, which compare the midquote at various times during the trading day to the prior closing midquote. Measurements are taken every 5 minutes in the first and last half hours and every 30 minutes otherwise, using bid and ask data for the 3,000 largest U.S. stocks from 1996-2008. Ratios falling outside the 95% confidence intervals, built from the standard error of the time series mean across days, indicate statistical significance.
Are overnight price bumps bigger for hard-to-arbitrage stocks than for other stocks?
Overnight price bumps are larger for stocks that are difficult to value and costly to arbitrage, such as illiquid stocks with high short interest. This subsample averaged overnight returns of 0.4% to 0.6% and trading day reversals of -0.4% to -0.7%, versus 0.1% and -0.07% for all stocks. The effect was also more than twice as large in high-sentiment months as in low-sentiment months.
Has the overnight price reversal pattern weakened over time?
The overnight price reversal pattern has weakened since decimalization in 2001 and the expansion of algorithmic trading in 2005. The findings come from a 1996-2008 sample of the 3,000 largest U.S. stocks, so they may not describe more recent markets. The pattern holds across all stock styles and is somewhat stronger on Mondays, but it is concentrated in roughly the first hour of the trading day.