What Drives Intraday Reversal? Illiquidity or Liquidity Oversupply?

What drives intraday reversal? Previous studies of the U.S. market regard short-term reversal as compensation for liquidity provision. However, in this paper, we find that intraday reversal has no significant dependence on stock liquidity for the Chinese market. Hence, based on a stylized framework, we propose an alternative explanation: uninformed retail traders who underreact to news trade against previous price movement, which generates an opposing price pressure. The empirical results confirm this liquidity oversupply explanation. The negative correlation between previous intraday returns and future returns in the Chinese market is reversed once we extend the holding period. This indicates that reversal is a pricing error due to excessive liquidity provision from uninformed retail traders instead of a price correction from a temporary price concession due to lack of liquidity