Does time of day impact financial market returns?

2020 Northern Finance Association Conference

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Clock, empty bed © sandboxstudio /123RF Stock PhotosWhile many drivers can influence stock market returns, it turns out the time of the day may play an important role.

In particular, the four hours around the time Asian markets close and European markets open account for the entire market returns when looking at E-mini S&P 500 futures, according to the paper by Dmitriy Muravyev, an associate professor of finance at Michigan State University, and Oleg Bondarenko, a finance professor at the University of Illinois.

In particular, between 2004 and 2018, the four hours between 11:30 p.m. and 3:30 a.m. EST saw a 7.6 per cent annualized return, the paper said. In addition, it noted the time period’s Sharpe ratio is very high, overnight volatility is low and during the other 20 hours of the day average returns are virtually zero.

The researchers say the returns can be linked to increased certainty that arises when European investors help process information from Asian trading hours.

The paper tested out its theory by accounting for Daylight Saving Time. “We can use Daylight Saving Time to show that, from the perspective of European investors, the return pattern we see will be the same in the winter and in the summer,” Muravyev says. “But from the Asian investor, we see a one-hour shift. And this prompts us that this price run-up during the four-hour period is due to European open.”

When Asian markets are open, information keeps coming in but isn’t fully processed, Muravyev explains. “Unprocessed information accumulates through the overnight session. And during European open, obviously, many large European investors come into the market. They can process [the] information which was accumulated and, by doing this, they essentially reduce the uncertainty.”

While Asia is very large in terms of the global economy, its amount of investment managers is small compared to Europe or North America. “There is a gap [between] how big the economy [is] and how big the money management industry [is] in Asia,” Bondarenko says.

Muravyev makes an analogy to online shopping through Amazon.com Inc. where, if a product has five reviews, it’s too few to have an opinion on the product, but once it gets up to hundreds of reviews, it’s probably enough to evaluate. He compares the five reviews to the Asian time zone, 100 reviews to Europe and 1,000 reviews to the U.S. “Essentially, if you have 1,000 reviews, that’s great, but after 100 reviews, you already figure out whether this product is essentially good or bad.”

Overall, the paper suggested ag strategy of buying future before and selling after European open. While the strategy can come along with transaction costs, it noted, it remains profitable, even after these costs.

“. . . Even for long-term investors who do not do high-frequency trading, this pattern is very useful because it allows you to time when to buy and to sell,” says Bondarenko. “If you’re going to increase your position in the market, it’s better to do it right before the E.U. market open starts. If you have to sell for other reasons, it tells the best time when you need to execute the strategy.”

The paper was presented at the Northern Finance Association’s 2020 conference. The Canadian Investment Review is a proud partner of the NFA conference.

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