Asymmetrical impacts from overnight returns on stock returns

Abstract

This paper documents significant relationship between overnight returns and future stock returns in the long-term where high averages of overnight returns lead to low future stock returns, with formation periods ranging from 1 month to 1 year. On the other hand, variations in overnight returns lead to different reactions of future stock returns, depending on the levels of past return performances and stabilities of momentum effects. Return reversals are strongest for stocks with extreme past returns. When momentum effects are volatile, higher variations of overnight returns lead to higher future stock returns. When momentum effects are stable, lower variations of overnight returns lead to higher future stock returns for stocks with extreme positive past returns; for stocks that perform worst in the past few months, the two variables have a non-linear relationship. A set of sample sorting criteria according to above relationship are found to significantly enhance the profitability of momentum trading strategy.