The overnight return puzzle and the “T+1” trading rule in Chinese stock markets

Abstract

Overnight returns in Chinese stock markets are on average negative. This overnight return puzzle appears to be unique to Chinese markets. We hypothesize that a particular arrangement in Chinese stock markets explains the puzzle: the “T+1” trading rule. T+1 trading prohibits traders from selling the shares they bought on the same day. This restriction leads to a discount on daily opening prices. We find empirical support that the T+1 induced discount explains the overnight return puzzle and estimate the average T+1 discount at 14 bps. In addition, we establish that the T+1 discount contributes significantly to overnight risk.