New Avenues in Expected Returns : Investor Overreaction and Overnight Price Jumps in US Stock Markets

Using a very large data set with more than 9,700 stocks listed on NYSE, AMEX and NASDAQ, we analyze overnight price jumps and report short-term investor overreaction to information shocks and document return reversal and predictability up to five days. For negative and positive overnight jumps, results are significant with Newey-West adjusted t-stats and robust to various model specifications. In the cross-section, degree of reversal is considerably larger for stocks that are less costly to arbitrage. In contrast to this overreaction, a zero-cost contrarian trading strategy with extreme decile portfolios -shaped according to lagged jump returns- incurs 0.8% of risk-adjusted loss in 1-month investment horizon. Together, these connote that documented overreaction and return reversal are short-term market phenomena. With novel findings for jump stocks, present study also builds a new avenue for overnight and intraday expected returns in the recently renowned "tug of war" literature which rests on investor heterogeneity. We show that jump stocks have significantly different abnormal returns than non-jump stocks in both overnight and intraday components for the next month. Our study stands at the intersection of overreaction, jump and return predictability literature by paying special attention to investor behaviours around price discontinuities and post-shock return dynamics