The effects of overnight events on daytime trading sessions

This study investigates the association between overnight and daytime-trading session returns in U.S. equity markets over the last 14 years and interprets it using the overreaction hypothesis. To identify the effects of overnight overreactions on daytime trading sessions, we control for daily investor sentiment, firms' fundamental variables, and risk factors. Our results suggest that investors tend to overreact overnight and react more dispassionately during daytime trading sessions. Investors' reactions differ across sectors, and the degree of overreaction is greater in cyclical industries than in defensive industries. Additionally, we analyze the impacts of overnight reactions on daytime trading sessions focusing on recession periods. The impacts differ by subperiods and are pronounced during the Global Financial Crisis and the onset of the COVID-19 pandemic. Investors' reactions to overnight news events also respond differently to demand and supply shock-induced recessions.

Examining the sources of excess return predictability: Stochastic volatility or market inefficiency?

We use a consumption based asset pricing model to show that the predictability of excess returns on risky assets can arise from only two sources: (1) stochastic volatility of fundamental variables, or (2) departures from rational expectations that give rise to predictable investor forecast errors and market inefficiency. While controlling for stochastic volatility, we find that a variable which measures non-fundamental noise in the Treasury yield curve helps to predict 1-month-ahead excess stock returns, but only during sample periods that include the Great Recession. For these sample periods, higher noise predicts lower excess stock returns, implying that a shortage of arbitrage capital in financial markets allowed excess returns to drop below the levels justified by fundamentals. The statistical significance of the predictor variables that control for stochastic volatility are also typically sensitive to the sample period. Measures of implied and realized stock return variance cease to be signficant when the COVID-influenced data from early 2020 onward is included.