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Heterogeneous liquidity providers and night-minus-day return predictability

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  • Lu, Zhongjin
  • Malliaris, Steven
  • Qin, Zhongling

Abstract

We present and test a model to understand the puzzling fact that characteristics-sorted stock portfolios tend to earn opposite-signed overnight and intraday expected returns. Heterogeneous arbitrageurs – “fast” arbitrageurs with informational advantages and “slow” arbitrageurs with low inventory costs – compete to determine the price of liquidity. High information asymmetry around market open allows fast arbitrageurs to demand large price deviations for absorbing order imbalances, as cream-skimming risk discourages competition from slow arbitrageurs. Despite persistent order imbalances, these deviations attenuate when cream-skimming risk subsides, leading to opposite-signed overnight and intraday returns. Our model identifies novel determinants that empirically explain substantial variations in predictable overnight-minus-intraday returns.

Suggested Citation

  • Lu, Zhongjin & Malliaris, Steven & Qin, Zhongling, 2023. "Heterogeneous liquidity providers and night-minus-day return predictability," Journal of Financial Economics, Elsevier, vol. 148(3), pages 175-200.
    • Handle: RePEc:eee:jfinec:v:148:y:2023:i:3:p:175-200
    DOI: 10.1016/j.jfineco.2023.03.002
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    More about this item

    Keywords

    Fast and slow arbitrageurs; Return predictability; Overnight and intraday returns; Endogenous limited participation; Liquidity provision;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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