Do overnight returns explain firm-specific investor sentiment in China?

Abstract

We are the first to investigate whether close-to-open overnight returns can measure firm-specific investor sentiment in China. Empirically, we find that in the short term, overnight returns persist for up to four weeks, and the persistence is stronger for hard-to-value firms, confirming the result for the US; in the longer run, stocks with high (low) overnight returns underperform (outperform), consistent with the US evidence too. We further show that overnight returns negatively predict future stock returns in the cross-section, and this predictability remains strong after controlling for firm characteristics. Finally, the strategy that buys stocks in the highest overnight-return decile and sells stocks short in the lowest decile generates abnormal returns of 41 and 40 basis points per month for the Fama-French three-factor model and Fama-French-Carhart four-factor model, respectively. Therefore, overnight returns seem to be a suitable proxy for measuring firm-specific sentiment in China.