On Overnigh Reurn Premiums of Inernaional Sock Markes Mei Qiu and Tao Cai Deparmen of Economics and Finance (Albany), Massey Universiy Absrac We sudy he daily close-o-opening overnigh reurns of sock indices of hiry-wo developed and emerging markes. Overnigh reurns are generally less volaile han he rading-period reurns and overnigh reurn premiums are repored for weny markes. Excess overnigh reurns over he rading-period reurns are higher following a period of rading when differences of opinion were low bu lower when divergence of opinion is going o be high on he nex rading day. Higher overnigh reurn premiums are observed for he markes ha have shor sale consrains. Our findings sugges ha invesors are generally beer off buying a close bu selling a opening, especially so on hose markes ha have high level of informaion asymmery and shor selling is no commonly praciced. Keywords: Opinion divergence, shor sale consrain, overnigh sock reurn
I. Inroducion Superior reurn earned over a non-rading period is one of he many differen ypes of financial marke anomalies. French and Roll (1986) find i puzzling ha sock reurns are more volaile during he rading-hours han marke closures over he weekends. They argue his phenomenon is caused by he differences of informaion flow and mispricing of socks during he rading and he non-rading hours. Amihus & Mendelson (1991) and Masulis & Ng (1995) repor ha volailiy of inraday reurns are larger han ha of overnigh reurns in sock markes of Japan and U.K. Branch and Ma (2006) find overnigh reurns of U.S. socks are negaively correlaed wih reurns generaed during he rading hours afer rading aciviy resumes he following morning. Cooper, Cliff and Gulen (2008) repor individual socks, sock indices and sock index fuures offer beer reurns over he nigh non-rading period han over he rading-hours during he day in he U.S. More ineresingly, hey find volailiies of overnigh reurns are lower han hose of rading-period reurns. Tompkins and Wiener (2008) repor similar findings for heir sudy on sock index fuures of four major economies including Germany, France, Japan and he U.K. A number of facors are claimed by finance lieraure o be relaed o he level of marke efficiency. For example, Chiou, lee and Lee (2010) find ha sock reurns are relaed o he sae of marke developmen based on he evidence ha sock reurns are lower, bu riskier, in emerging markes han in developed markes. Bris e al. (2008) relae marke anomalies o shor sale resricions. They sudy boh cross-secional and ime series analysis based on daa from 46 equiy markes and find ha sock prices incorporae informaion faser in counries where shor selling is permied by law and commonly 2
praciced. Furhermore, Shamsuddin and Kim (2010) show ha marke reurns are less predicable, hus more efficien, in counries which have no shor-selling resricions. Miller (1977) proposes ha shor-selling consrains lead o he overpricing of socks when invesors have disagreemens abou heir prices. Miller argues ha, as pessimisic invesors are unable o sell shor while opimisic invesors can coninue o buy long wih shor-sale consrains, he demand and he supply for a sock will become unbalanced when invesors disagree abou is value. As a resul, marke force will push up he sock price and lead o he overpricing of sock. In ligh of Miller s argumen, Dieher, Malloy and Scherbina (2002) observe lower fuure reurns o socks having higher dispersion of invesor opinions. They argue ha sock prices end o reflec opimisic views raher han pessimisic views when invesors have differen opinions abou he socks and pessimisic invesors ry o avoid rading. Therefore, socks subjec o higher dispersion of invesor opinions end o be overpriced and correcions o he overpricing in he fuure would resul in lower reurns o affeced socks. On he oher hand, Ofek and Richardson (2003), Jones and Lamon (2002) and Chen e al. (2002) find overpricing is more serious for socks having greaer shor sale consrains as hese socks provide lower fuure reurns. Asquih e al. (2005) argue ha here are wo necessary condiions of binding shor sale consrains; he supply of he sock mus be low, and he demand of shoring such sock mus be high. They use insiuional ownership o accoun for he supply side of he shares, and relaive shor ineres o accoun for he demand for shoring. They find ha socks wih boh low 3
insiuional ownership and high shor ineres experience greaer overpricing. Nagel (2005) also repors ha socks having low insiuional ownerships end o provide superior risk-adjused reurns. Berkman e al. (2008) observe significanly higher overnigh reurns and price reversals during he day from large socks in he U.S. They show ha he differences beween overnigh reurns and rading-hour reurns are so large ha a close-o-open rading could generae significan gain which would be high enough o cover ransacion coss. They argue ha his phenomenon is caused by he overpricing of socks a marke openings due o he increasing dispersion of invesors opinions accumulaed over he non-rading hours a nigh and he inabiliy o rade by pessimisic invesors under shor selling consrains. In he spiri of Miller (1977), Boehme, Danielsen and Sorescu (2009) clarify ha boh high dispersion of opinion and shor-sale consrains are necessary condiion for overpricing of socks as hey find no sysemaic overpricing when only one of he wo condiions is no me. Alhough several sudies have been done o show ha he overnigh reurn anomaly exiss in he US and a few oher developed financial marke, lile is known abou wheher his anomaly exiss in oher markes. If his anomaly exiss in oher inernaional sock markes, effecive rading sraegies could be developed o help inernaional sock invesors o capure he differences beween he higher opening prices and he lower preceding closing prices. If he magniudes of abnormal overnigh reurns are large enough, such sraegies may work beer han a simple close-o-close buy-and-hold sraegy. Such profiable opporuniies, however, do no seem o be exploied by invesors since he anomaly should oherwise go away. Is he overnigh 4
reurn anomaly unique o he US, or is i a feaure applicable o oher inernaional sock markes? This research inends o answer his quesion by examining he index daa of a wide range of inernaional sock markes. Previous sudies on his opic focus on well-developed financial markes in he U.S. and a few oher major economies which have raher relaxed rules on shor-selling pracice. The purpose of his research is o examine wheher overnigh reurn anomaly exiss in some oher counries. In paricular, we look a sock markes of hiry-wo counries including boh developed and emerging markes. As shor-selling legislaions and pracices are differen in differen counries, our daase provide us an opporuniy o examine he effec ha shor-selling consrains have on overnigh reurn anomaly. We have wo main findings. Firs, overnigh reurns are generally higher, bu less volaile, han opening-o-lose reurns in weny counries; and even more so in emerging markes. Second, overnigh reurn premiums, which are differences beween overnigh reurns and rading-period reurns realized on he same day, are higher in counries ha have shor-selling resricions. Our resuls indicae ha shor selling pracice may abae overnigh reurn anomaly and improve marke efficiency. The pracical implicaion of our findings is ha invesors are generally beer off buying a close and selling a opening, provided hey have decided o rade. The res of he paper proceeds as follows. We provide deails abou daa and research mehodology in he nex secion. We hen presen our research findings in Secion III and conclude in Secion IV. II. Daa and Research Mehod We obain informaion for any counry ha are included in eiher he MSCI Developed Markes Index or he MSCI Emerging Marke Index and have a leas five years daa 5
available for sudy. The sample includes 18 developed markes and 14 emerging markes. A lis of all sample counries is provided in Table A1 in he Appendix. For sock marke of each counry, we obain several ypes of informaion from various sources. We download from Daasream, or Yahoo Finance, daily daa for opening price (PO), inraday high (PH), inraday low (PL) and closing price (PI) of sock marke index for he period from January 1 s 2000 o December 31s 2009. This ime period is chosen o obain sufficien daa for all counries ha we sudy. The period also includes a complee cycle of ups and downs of inernaional sock markes. We collec informaion abou shor sale regulaion and pracice of each counry from wo papers by Bris, Geozmann and Zhu (2008) and Charoenrook and Daouk (2005) and also he websies of naional sock exchanges. For each individual naional sock marke index, we calculae he close-o-close daily reurn (DR), he opening-o-close overnigh reurn (ONR) and he close-o- opening rading-period reurn (TPR) using formulae (1), (2) and (3), respecively. DR (Close / Close ) 1 (1) 1 ONR (Open/ Close) 1 (2) 1 TPR (Close / Open ) 1 (3) Noe ha he sum of overnigh reurn and rading-period reurn is he daily reurn on any given day. The diagram depiced in Figure 1 shows he relaion of he above hree reurns. 6
Figure 1 Composiion of daily reurns Close -1 Open Close Overnigh Reurn (ONR ) Trading-period Reurn (TPR ) Daily Reurn (DR ) We define overnigh reurn premium (ONRP ) as he excess of overnigh reurn over he rading-period reurn, calculaed using Equaion (4): ONRP = ONR TPR (4) where PI and PO are closing price and opening price, respecively; PH and PL are inraday high and inraday low, respecively; of a sock index. Subscrips and (-1) denoes for observaions made on day and (-1), respecively. In order o invesigae he relaionship beween overnigh reurn premium and invesors divergence of opinion and shor-selling consrains, we conduc a panel regression es in he form of Equaion (5). The dependen variable is a marix of daily overnigh reurn premiums (ONRP) of a cross secion of naional sock marke indices. There are hree independen variables. The firs wo independen variables are marices of divergence of opinions, one for he rading day before he marke closure a nigh and one for he rading day afer he marke reopens he nex morning. The hird independen variable is a marix of shor-selling consrain dummy. Since invesor behaviour may vary across differen markes while shor selling consrain is likely o exer he same influence on he efficiency of differen markes, we allow cross secion differences for coefficien 7
esimaes for he wo divergence of opinion variables bu esimae a common coefficien for he shor selling consrain dummy variable. ONRP = C + α DO + β DO + λ SS (5) i i i i( 1) i i i where DO i and DO i(-1) measure he levels of for counry i s invesors divergence of opinion on he day an overnigh reurn premium is measured and he day before ha day; SS is a dummy variable for shor-selling consrains which akes he value of zero if shor sale is allowed and commonly praciced, or a value of one if shor sale is eiher prohibied by law or is rarely praciced due o resricions on securiy lending or oher reasons. As we use counry-level sock index daa, some proxies for measuring divergence of opinion on individual socks commonly used in finance lieraure are eiher no available, or no suiable, for he purpose of his sudy. From he daa we have, we measure divergence of opinion by relaive range of index level calculaed as he spread beween he highes price and he lowes price in any given day adjused by he level of closing price. Equaion (6) specifies how we esimae he level of divergence of opinion. DO = (PH PL ) / PI (6) We allow cross-secion variaions of coefficiens for he wo divergences of opinion variables and obain a common coefficien for he shor-selling consrain dummy variable. We also run Granger Causaliy ess, counry by counry, o check if overnigh reurn premium is caused by divergence of opinion. We repor he resuls in Table A2 in he Appendix. We repor and discuss our resuls in he nex secion. 8
III. Resuls and Discussions Summary saisics for he average daily overnigh and rading-period reurns for all hiry-wo sock markes are presened in Table 1. The resuls show ha he overnigh reurns are higher han he rading period reurns and he close-o-close reurns in 13 developed markes and 8 emerging marke. The average overnigh reurns, averaged across he sample counries, are 0.0457% and 0.0394% higher han he average dayime reurns, in developed and emerging markes, respecively. The above resul indicaes ha alhough overnigh reurn anomaly is more widespread in developed counries, he magniude of overnigh reurn premium has no difference across he developed and emerging markes. Our finding of he absence of he anomaly in he US marke, however, is inconsisen wih he findings of Cooper e al. (2007) and Berkman e al. (2008), boh of which repor significan overnigh reurn anomaly in he US. Is he superior overnigh reurn associaed wih higher risk? We repor he sandard deviaions of he close-o-close, he overnigh and he dayime reurns in Table 2. Our resuls show ha overnigh reurns are less volaile han dayime reurns in all counries excep for Israel. This resul suggess ha higher overnigh reurn is no associaed wih higher risk during he marke closure a nigh, evidence ha conradics he heory of risk-reurn rade-off. 9
Table 1 Overnigh reurn versus rading-period reurn in differen markes We repor he averages of daily reurn (DR), overnigh reurn (ONR), rading-period reurn (TPR) and overnigh reurn premium (ONRP) for sock marke index of each counry. Panel A repors resuls for developed markes and panel B repors resuls for emerging markes. Counry No of obs. DR ONR TPR ONRP Panel A: Developed markes Ausria 2,364 0.0216% -0.0013% 0.0414% -0.0242% Ausralia 1,561 0.0309% 0.0159% 0.0165% 0.0023% Belgium 2,511-0.0219% 0.0590% -0.0639% 0.1306% Canada 2,515 0.0210% 0.0479% -0.0256% 0.0735% Finland 2,508-0.0111% 0.0015% -0.0119% 0.0134% France 2,514-0.0145% 0.0346% -0.0416% 0.0833% Germany 2,502 0.0034% 0.0073% 0.0028% 0.0119% Hong Kong 2,399 0.0177% 0.0363% -0.0211% 0.0556% Ireland 2,418-0.0093% -0.0093% -0.0004% -0.0089% Ialy 2,294-0.0264% 0.0387% -0.0579% 0.1047% Japan 2,335-0.0468% 0.0185% -0.0445% 0.0863% Neherlands 2,514-0.0198% 0.0333% -0.0451% 0.0865% Porugal 2,472-0.0018% 0.0469% -0.0498% 0.0967% Singapore 2,425 0.0094% 0.0484% -0.0323% 0.0872% Spain 2,034 0.0272% 0.0072% 0.0195% -0.0129% Swizerland 2,464-0.0022% 0.0251% -0.0210% 0.0524% UK 2,464-0.0052% -0.0013% 0.0045% -0.0026% US 2,515 0.0121% -0.0006% 0.0131% -0.0137% Average -0.0009% 0.0227% -0.0176% 0.0457% Panel B: Emerging markes Brazil 2,476 0.0752% 0.0133% 0.0674% -0.0541% China 2,411 0.0449% -0.0135% 0.0625% -0.0760% Colombia 1,471 0.1181% 0.0190% 0.1024% -0.0833% Hungary 2,200 0.0625% 0.0669% -0.0022% 0.0689% India 2,347 0.0494% 0.1476% -0.0850% 0.2443% Indonesia 2,295 0.0671% -0.0197% 0.0835% -0.1064% Israel 1,108 0.0705% 0.0953% -0.0287% 0.1185% Korea (Souh) 2,352 0.0295% 0.0591% -0.0246% 0.0881% Malaysia 2,356 0.0225% 0.0177% 0.0082% 0.0129% Mexico 2,415 0.0754% 0.0025% 0.0690% -0.0701% Philippines 2,209 0.0450% 0.0374% 0.0087% 0.0287% Poland 2,284 0.0485% 0.0106% 0.0393% -0.0287% Taiwan 2,382 0.0063% 0.1265% -0.1197% 0.2448% Thailand 2,438 0.0320% 0.1421% -0.1102% 0.2523% Average 0.0534% 0.0503% 0.0050% 0.0457% 10
Table 2 Sandard deviaion of daily reurn, overnigh reurn and rading-period reurn in differen markes We repor he average sandard deviaion of daily reurn (σ DR ), overnigh reurn (σ ONR ) and rading-period reurn (σ TPR ) for sock marke index of each counry. Panel A repors resuls for developed markes and panel B repors resuls for emerging markes. Counry σ DR σ ONR σ TPR Panel A: Developed markes Ausria 1.4894% 0.0946% 1.4981% Ausralia 1.1263% 0.0159% 0.9592% Belgium 1.3610% 0.7173% 1.1804% Canada 1.2785% 0.8269% 1.0575% Finland 2.0988% 0.5427% 2.0446% France 1.5773% 0.9046% 1.3169% Germany 1.6634% 0.4386% 1.5656% Hong Kong 1.7036% 1.1100% 1.2315% Ireland 1.4977% 0.2434% 1.5303% Ialy 1.3214% 0.6837% 1.1445% Japan 1.5758% 0.6436% 1.3037% Neherlands 1.6344% 0.9053% 1.3466% Porugal 1.1015% 0.5666% 0.9701% Singapore 1.3210% 0.6407% 1.1778% Spain 1.3752% 0.7371% 1.1163% Swizerland 1.3097% 0.7322% 1.0866% UK 1.3396% 0.0595% 1.3383% US 1.3451% 0.0267% 1.3695% Average 1.4511% 0.5494% 1.2910% Panel B: Emerging markes Brazil 1.9789% 0.1296% 2.0178% China 1.6691% 0.7417% 1.6025% Colombia 1.5992% 0.4651% 1.6419% Hungary 1.6797% 0.9168% 1.4465% India 1.7631% 0.9080% 1.6075% Indonesia 1.5078% 0.7196% 1.3429% Israel 1.4008% 1.2002% 0.9121% Korea (Souh) 1.8269% 1.1661% 1.4623% Malaysia 0.9815% 0.4969% 0.8534% Mexico 1.5189% 0.0899% 1.5147% Philippines 1.1895% 0.6196% 1.1276% Poland 1.3906% 0.7923% 1.1757% Taiwan 1.6250% 1.1120% 1.3457% Thailand 1.5320% 0.8244% 1.3715% Average 1.5474% 0.7273% 1.3873% 11
Nex, we repor in Table 3 he key resuls of he panel regression in he form of Equaion (5), which examines he relaionships beween he magniude of overnigh reurn premium and he level of invesors divergence of opinion and he variaion of shor selling consrains across all counries in our sample. Since we allow for cross-counry variaions of he coefficiens for he wo divergences of opinion variables, we obain hiry-wo ses of coefficien esimaes; each is differen from one anoher, for all counries we sudy. To be succinc, only he averaged values of esimaed coefficiens 1 are repored in Table 3. The dummy variable for shor selling consrain is se as a common variable, which means i has a common coefficien for all counries. Table 3 Summary resuls of panel regression We run panel regressions in he form of Equaion (5): ONRP = C +β DO +β DO i i 1 i 2 i( 1) + λ SS Dependen variable ONRP is a marix of overnigh reurn premiums calculaed as he difference beween overnigh reurn and he reurn realized during he rading period. Independen variables DO and DO -1 are marices of expeced values of divergences of opinion on he day marke reopens afer closure and he day before he closure a nigh. Dummy variable SS is a marix of shor sale consrains which akes he value of zero if shor sale is allowed and commonly praciced and he value of one oherwise. We esimae a common coefficien for he shor-selling consrain dummy bu allow cross secion variaions of he wo divergences of opinion coefficiens. For each independen variable, we repor esimaed coefficien followed by -saisics (in parenheses) and p-value. The symbol *** denoes for saisical significance a he one percen level. Variable Coefficien (cross-counry average) Lagged divergence of opinion (β 1 ) Divergence of opinion (β 2 ) Shor selling consrain dummy (λ) -10.94 17.84 0.06 -sas -3.68*** 5.77*** 4.44*** (cross-counry average) Adj-R 2 2.14% i. The resuls of Table 3 sugges ha overnigh reurn premiums are lower following a period of rading when differences of opinions among invesors were high before he markes close for he nigh. On he oher hand, higher overnigh reurn premiums are observed when he divergence of opinion is going o be high on he nex rading day. Consisen wih Miller (1977) s conjecure ha divergence of opinion end o resul in 1 Deailed resuls for individual counries are available from he auhors upon reques. 12
he overvaluaion of an asse in a shor selling consrained environmen, we find ha overnigh reurn premiums are indeed higher in counries where shor sellings are prohibied or rarely praciced. The negaive coefficien of divergence of opinion before marke closure seems o sugges ha invesors are more cauious when divergence of opinion was high during he day before markes are closed for he nigh. Therefore, invesors end o be more conservaive bidding up prices when marke resumes he nex morning. On he oher hand, greaer disagreemens among invesors during he nigh and he rading hours afer marke resume he nex morning lead o higher overnigh reurn premiums. Beween he divergences of opinion measured over he wo periods, one before he nigh and he oher including and afer he nigh, he second facor dominaes as indicaed by is larger coefficien in absolue erm. Our resuls are generally consisen wih Berkman e. al. (2008) and suppor Miller (1977) s argumens. The resuls of Granger Causaliy ess repored in Table A2 of he Appendix sugges ha he divergence of invesors opinions does Granger cause he overnigh reurn premium in mos of he counries we sudy. IV. Conclusions This research examines he anomaly of superior overnigh non-rading period reurns of inernaional sock markes. Using sock index daa of hiry-wo counries, we find ha he anomaly exiss in weny counries including boh developed and emerging markes. We find ha he superior overnigh reurns are no jusified by he risk-reurn rade off as overnigh reurns are less volaile han rading-period reurns. The resuls of a panel 13
sugges ha greaer divergences of opinion lead o higher overnigh reurn premiums and ha shor sale consrains exacerbae he anomaly. The findings of his sudy have boh policy and pracical implicaions. Firs, improving he qualiy of informaion flow will help o reduce he divergence of opinion among invesors, which will in urn alleviae overnigh reurn anomaly. Second, marke paricipans may be beer off buying a close and selling a opening if hey have decided o rade. Our research also conribues o he lieraure as i is, o our knowledge, he firs overnigh anomaly sudy using counry-level daa of sock markes of a broad range of emerging and developed counries. The large daase of ime series daa of a broad lis of counries allows us o es he roles ha divergence of opinion and he marke-wide consrains on shor sales using panel regression. A possible exension o his sudy is o examine he paern of price change during he rading hours, especially a he opening and closing, o idenify wheher i is he overpricing a he opening, or he underpricing a he closing of he markes ha leads o higher overnigh reurn. This will apparenly involve he sudy of ick daa a he counry level. The findings of he above resuls have boh policy and pracical implicaions. Since improving he coninuous flow of informaion may reduce divergence of opinion among invesors, our findings sugges ha improving informaion flow and relaxing consrains on shor sales may help o abae he magniude of overnigh reurn anomaly. One pracical implicaion of our findings is ha invesors are generally beer off buying a close and selling a opening if hey have decided o rade. 14
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Appendix Table A1 Lis of sample counries Counry Shor sale resricion** Panel A: Developed Markes Ausralia Ausria Belgium Canada Finland Allowed bu rarely praciced France Germany Hong Kong since March 1994 Ireland Ialy Japan Neherlands Porugal Singapore No allowed Spain Allowed bu rarely praciced Swizerland Unied Kingdom USA Panel B: Emerging Markes Brazil Allowed bu rarely praciced China No allowed Colombia No allowed Hungary Allowed bu rarely praciced India No allowed for insiuional invesors Indonesia Allowed in 1996 bu rarely praciced Israel Allowed bu rarely praciced Malaysia Allowed in 1995 bu prohibied in 1997 Mexico Allowed Philippines Allowed in 1996 bu rarely praciced Poland Allowed bu rarely praciced Souh Korea No Allowed Taiwan Allowed bu rarely praciced Thailand since 1999 Noe: Informaion abou shor sale resricions come from Bris, Geozmann and Zhu (2008), Charoenrook and Daouk (2005) and he websies of naional sock exchanges. 17
Table A2 Granger causaliy es resuls For each counry we run Granger causaliy es which has a null hypohesis ha divergence of opinion granger causes overnigh reurn premium. Symbols *, ** and *** denoe for saisical significances a he en percen, five percen and one percen levels. Counry DO Granger causes ONRP p-value Ausralia Accep 0.006*** Ausria Rejec 0.256 Belgium Accep 0.000*** Canada Accep 0.000*** Finland Accep 0.009*** France Accep 0.068* Germany Accep 0.003*** Hong Kong Accep 0.000*** Ireland Rejec 0.2327 Ialy Accep 0.040** Japan Accep 0.021** Neherlands Rejec 0.132 Porugal Accep 0.000*** Singapore Rejec 0.156 Spain Rejec 0.355 Swizerland Accep 0.094* Unied Kingdom Accep 0.072* USA Rejec 0.307 Brazil Accep 0.000*** China Accep 0.000*** Colombia Rejec 0.217 Hungary Accep 0.000*** India Accep 0.000*** Indonesia Rejec 0.823 Israel Accep 0.026** Korea (Souh) Rejec 0.225 Malaysia Accep 0.019** Mexico Accep 0.033** Philippines Rejec 0.839 Poland Accep 0.010* Taiwan Accep 0.000*** Thailand Accep 0.021** 18