Price Discovery and Trading After Hours

Abstract

We examine the effects of trading after hours on the amount and timing of price discovery over the 24-hour day. A high volume of liquidity trade facilitates price discovery. Thus prices are more efficient and more information is revealed per hour during the trading day than after hours. However, the low trading volume after hours generates significant, albeit inefficient, price discovery. Individual trades contain more information after hours than during the day. Because information asymmetry declines over the day, price changes are larger, reflect more private information, and are less noisy before the open than after the close. Technology has dramatically changed the way stock markets operate by allowing investors to trade directly with each other, both during and outside of exchange trading hours. Although it is now relatively easy to trade after hours, in reality most investors do not. Only 4% of Nasdaq trading volume occurs after hours. This article examines how investors’ decisions to trade after hours or during the trading day affect the process through which new information is incorporated into security prices. We find that relatively low after-hours trading volume can generate significant price discovery, although prices are noisier after hours, implying that the price discovery is less efficient. Variation in the amount of informed and uninformed trading is relatively small, both within the trading day [Admati and Pfleiderer (1988), Wood, McInish, and Ord (1985), Madhavan, Richardson, and Roomas (1997)] and across trading days [Foster and Viswanathan (1993)]. In contrast, there are large shifts in the trading process at the open and at the close. These large shifts make it possible to examine price discovery under conditions very different from those studied previously and allow us to address the following four questions regarding the relationship between trading and price discovery. First, how does the trading process affect the