Profitable Mean Reversion after Large Price Drops : A Story of Day and Night in the S&P 500, 400 Mid Cap and 600 Small Cap Indices

The motivation for this paper is to show the usefulness of the information contained in the open-to-close (day) and close-to-open (night) periods compared to the more frequently used close-to-close period. To show this we construct two versions of a contrarian strategy, where the worst performing shares during the day (resp. night) are bought and held during the night (resp. day).We show that the strategies presented here generate a significant alpha and their returns cannot be solely explained by the factors derived from Fama and French (1993) 3-factor model and a modified 5-factor model introduced by Carhart (1997). Even after we account for the bid-ask bounce effect the returns generated are significant and consistent. The information ratios of the two strategies mentioned for the entire period 2000-2010 vary between 1.59 and 6.70 depending on the capitalization of stocks. Overall, we show that opening prices contain information that is not generally fully utilized yet. The strategy proposed uses this information to add value and extract a significant alpha which cannot be explained by market factors