Divergence of Opinion, Short-Sale Constraints and the Weekend Effect

Abstract

This paper seeks to provide a new explanation for one of the most puzzled stock market anomalies: the weekend effect. As hypothesized by Miller (1977), stocks with higher divergence of opinion and more binding short-sale constraints are likely to be overpriced in the presence of information uncertainty. I argue that the weekend is an event that increases the ex-ante but reduces the ex-post uncertainty. Hence conditional on divergence of opinion and short-sale constraints, optimistic views are more likely to be reflected in the price immediately before the weekend in the presence of a rising level of information uncertainty, thereby inflating the share price on Friday. The share price is subsequently reverted back to the equilibrium when uncertainty is resolved through the passage of the weekend, therefore causing the famous Monday effect. Using both cross-sectional and time-series tests, I find that the Miller (1977) hypothesis is indeed an explanation for the weekend effect. In addition, this explanation is able to reconcile some previously documented patterns on returns surrounding the weekend, such as the negative relation between firm size and the weekend effect, the positive relation between short interest and the weekend effect and more negative Monday returns in bearish markets.