Chan, Chockalingam And Lai-Overnight Information And Intraday Trading Behavior - Evidence From Nyse Cross.pdf - Giełda książki fajna kolekcja - sylwian44

Journal of Multinational Financial Management

10 (2000) 495 – 509

www.elsevier.com:locate:econbase

Overnight information and intraday trading

behavior: evidence from NYSE cross-listed

stocks and their local market information

Kalok Chan a , Mark Chockalingam b , Kent W.L. Lai c, *

a Department of Finance , Hong Kong Uni 6 ersity of Science and Technology , Hong Kong

b Schering - Plough Health Care , Memphis , TN , USA

c Department of Accounting and Finance , Lingnan Uni 6 ersity , Tuen Mun , N . T . Hong Kong

Received 15 July 1999; accepted 4 March 2000

Abstract

In this paper we study how overnight price movements in local markets affect the trading

activity of foreign stocks on the NYSE. We ﬁnd that local price movements affect not only

the opening returns of foreign stocks, but also their returns in the ﬁrst 30-min interval. The

magnitude of local price movements is positively related to price volatility of foreign stocks,

and this relation is stronger at the NYSE open and weaker afterward. This result helps

explain why intraday price volatility is high at the open and lower at midday. However, local

price movements cannot account for intraday variations in trading volume. We also ﬁnd that

trading volume for foreign stocks is strongly correlated with NYSE opening price volatility

and weakly correlated with local market overnight price volatility. We interpret the result as

evidence that the trading activity of foreign stocks on the NYSE is related more to liquidity

JEL classiﬁcation : G14 Information and Market Efﬁciency; G15 International Financial Markets

Keywords : Intraday volatility; Market microstructure; Multiple-market trading

* Corresponding author. Tel.: 852-26168166; fax: 852-24664751.

E - mail address : kwlai@ln.edu.hk (K.W.L. Lai).

PII: S1042-444X(00)00030-X

496

K . Chan et al . : J . of Multi . Fin . Manag . 10 (2000) 495–509

1. Introduction

Extensive empirical evidence documents that the stock market is more active at

the beginning of the trading session. Measures of market activity, such as trading

volume, price volatility, and number of transactions, are higher at the open and

close for NYSE stocks (Jain and Joh (1988), Foster and Viswanathan (1993), and

Jang and Lee (1993)). Several studies conjecture that the higher market activity at

the open is due to overnight information that accumulates during the NYSE

nontrading period. For example, Berry and Howe (1994) document that the

number of news announcements released by Reuter’s News Service increases at 8:00

am (EST) — one and a half hours before the NYSE open — indicating an increase in

public information ﬂow before the open. Foster and Viswanathan (1993) show that

informed traders who gather private information during the nontrading period

trade more aggressively after the open if they suspect their information will become

public soon. Brock and Kleidon (1992) and Gerety and Mulherin (1992) argue that

because of the new information that arrives during the nontrading period, the

portfolio that is optimal during the previous close will no longer be optimal when

the market reopens. Therefore, market activity increases immediately after the open

as investors rebalance their portfolios.

In light of the relation between market activity and information ﬂow, many

authors examine internationally cross-listed stocks and check whether their price

behavior is different from that of non-cross-listed stocks, given their different

information-ﬂow patterns (Barclay et al., 1990; Kleidon and Werner, 1993; Chan et

al., 1994; Choe, 1994; Foster and George, 1994). Despite the intuitive appeal that

the trading behavior of these cross-listed stocks in the morning is related to

overnight information released in their local markets, none of these studies directly

tests this possibility.

In this paper we examine the intraday patterns of trading volume and price

volatility for stocks traded on the NYSE and listed on Asia-Paciﬁc and UK

exchanges. We test whether these patterns are related to public information

accumulated overnight. Unlike Berry and Howe (1994) who use the number of

news articles released during the nontrading period, or other researchers who use

close-to-open return volatility, we infer the overnight information ﬂow of these

cross-listed stocks directly from price movements in their local markets. Since most

information generated during the NYSE nontrading period about these foreign

stocks is reﬂected in local markets, local stock price movement is a good proxy for

overnight information. If the market activity at the open is related to overnight

information, we expect to ﬁnd a positive relation between the level of market

activity in the morning and the magnitude of local stock price movement.

Furthermore, as information about these foreign stocks (both public and private)

is more likely to arrive during the NYSE overnight period than during the trading

period, market activity is greater in the morning than the mid-day. This suggests

that once we control for the effect of overnight information (local stock price

movements), intraday variations in market activity will be reduced.

K . Chan et al . : J . of Multi . Fin . Manag . 10 (2000) 495–509

497

Unlike previous studies, we infer overnight information from the local price

movement rather than from the NYSE opening returns. Although the local price

movement and NYSE opening returns are closely related, they are not perfectly

correlated, as the price in one market could move because of the trading activity

there. Furthermore, local trading sessions for Asia-Paciﬁc stocks are closed before

the NYSE opens. Therefore, we examine how local price movements, which are

public information to US investors, affect the trading activity of foreign stocks on

US exchanges.

We ﬁnd that overnight price movements in local markets affect not only opening

returns of foreign stocks, but also returns during the ﬁrst 30 minutes. Also, the

magnitude of local price movements is positively related to the price movement of

foreign stocks in the morning. The relation is stronger around the open and weaker

afterward. This diminishing effect of overnight information on intraday price

movements helps explain why price volatility is higher at the open and lower at

midday. On the other hand, local price movements cannot explain intraday

variations in trading volume. This suggests that the trading volume of foreign

stocks on the NYSE is not related to overnight public information. We also ﬁnd

that trading volume is strongly correlated with NYSE opening price movement and

weakly correlated with local market price movement. We interpret this result as

evidence that the trading activity of foreign stocks on the NYSE is related more to

liquidity trading of US investors and less to local market information.

The paper proceeds as follows. Section 2 discusses the relation between overnight

information and intraday market activity. Section 3 describes the data and sum-

mary statistics. Section 4 presents empirical methodologies and results. Section 5

presents the conclusion.

2. Relation between overnight information and intraday market activity

2.1. Why market acti

ity is higher at the open

Extensive empirical evidence documents that stock market behavior at the

beginning of the NYSE trading session differs from the rest of the day. Wood et al.

(1985), Harris (1986), and Lockwood and Linn (1990) examine intraday stock

returns and ﬁnd that price volatility is higher near the open and close of the trading

session. Jain and Joh (1988), Foster and Viswanathan (1993), and Jang and Lee

(1993) ﬁnd that trading volume and number of transactions are also higher at the

open. Several explanations may account for this trading behavior. First, much

public information accumulates overnight and is not reﬂected in prices during the

NYSE nontrading period. Once the NYSE opens, overnight information is quickly

incorporated into prices, resulting in a large price movement at the open. Berry and

Howe (1994) and Mitchell and Mulherin (1994) examine the effect of public

information on market activity. Using the number of news announcements released

by Reuter’s News Service as a measure of public information ﬂow, Berry and Howe

(1994) document that information ﬂow substantially increases at 8:00 am (EST).

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K . Chan et al . : J . of Multi . Fin . Manag . 10 (2000) 495–509

Second, informed traders gather private information during the nontrading

period and may act strategically when trading with liquidity traders. This is

analogous to the interday trading strategies analyzed in Foster and Viswanathan

(1990). In their model, the informed trader receives private information at the

beginning of the week. Since a portion of the private information is made public

each day, the information becomes less valuable through time. The informed trader,

knowing a public signal is forthcoming, trades more aggressively so that more

information is reﬂected through trading. A similar logic can be applied to intraday

trading. If informed traders receive private information overnight and suspect the

information may be leaked later in the day, they will trade immediately after the

open.

Third, volume at the close and open reﬂects trades made to rebalance portfolios

before and after the overnight trading halt. Brock and Kleidon (1992) argue that

because of overnight information, portfolios that are optimal during the previous

close will no longer be optimal when the market reopens. Furthermore, portfolios

that are optimal at the close can differ, because of the imminent nontrading period,

from portfolios that are optimal during the continuous trading period. This

inelastic demand to trade induces a surge in trading activity at the open and close.

Fourth, since the NYSE operates continuously during the trading day, but

commences trading with a call auction, these two trading mechanisms could

generate different transitory volatilities. Amihud and Mendelson (1987) and Stoll

and Whaley (1990) document that open-to-open return variances are greater than

close-to-close return variances for stocks traded on the NYSE. This implies that

opening prices contain larger pricing errors than closing prices. However, subse-

quent studies (e.g., Amihud and Mendelson, 1991; Choe and Shin, 1993; Masulis

and Ng, 1995) ﬁnd similar evidence for stocks traded on other exchanges that have

different trading mechanisms. This suggests that higher transitory volatility at the

open is in fact due to the overnight trading halt. Without trading venues, the

overnight trading halt disturbs the process of price formation until the open

(Grundy and McNichols, 1989; Dow and Gorton, 1993; Leach and Madhavan,

1993). Gerety and Mulherin (1994) ﬁnd that transitory volatility declines during the

trading day both for the Dow Jones 65 Composite price index and for individual

ﬁrms in the Dow Jones 30 index.

2.2. A simple regression framework for understanding the effect of o

ernight

information

As discussed above, one reason for increased market activity at the open is that

overnight information accumulates during the NYSE nontrading period. This is

true even when the overnight information becomes public, since investors experi-

ence uncertainty in interpreting the information. Furthermore, as several re-

searchers (Grundy and McNichols, 1989; Dow and Gorton, 1993; Leach and

Madhavan, 1993) argue, multiple rounds of trading can produce prices that are less

noisy and reveal more information than a single round of trading. Therefore,

overnight information affects market activity at the open, but the effect diminishes

K . Chan et al . : J . of Multi . Fin . Manag . 10 (2000) 495–509

499

F t

denotes overnight information. If the effect of overnight information on market

activity diminishes during the day, then in a set of regression equations for different

intervals:

V t , t

at day t , and

a t

b t F t

e t , t

(1)

the

b t

coefﬁcient is larger for smaller

. Since the average of V t , t is given by

( t

a t

b t F (

(2)

a t ’s are the

same across all intervals. Equation (2) also suggests that if intraday variations in

V t , t are only due to innovations in overnight information, the

( t

could be higher for earlier intervals (smaller

), even though the

a t intercepts will have

F t is allowed to affect V t , t differently at different intervals. Note

that the regression models assume that variations in market activity are solely

caused by overnight information. This can be justiﬁed, especially for foreign stocks

that have much information released in local markets overnight. If other variables

contribute to intraday variations in market activity, the

a t

intercept will not be the

same even after controlling for

F t .

3. Data and summary statistics

We obtain data from the NYSE Trades and Quotes (TAQ) database. It com-

prises all trade records and quotation records on the NYSE, AMEX, and regional

exchanges. The trade records contain the time to the nearest second, date, ticker

symbol, price, and number of shares traded; the quotation records contain the time,

date, ticker symbol, bid and ask price, and number of shares the specialist quotes

for the bid and the ask. We also obtain data from the EXTEL database, which

comprises daily price records for most of the ﬁrms in the United Kingdom and

large ﬁrms worldwide. The prices are in terms of foreign currencies, and are not

translated into the US dollars. Therefore, the relationship between the price

movement in the US and foreign market is not due to exchange rate ﬂuctuation.

The sample period is the ﬁrst quarter of 1993. Since we are examining the effect

of overnight local information on NYSE trading activity, we select foreign stocks

whose local trading sessions precede the NYSE. To be included in the analysis, the

foreign stocks must be listed on the NYSE and have at least 20 days of more than

10 quotes a day. Each day, we match the transactions data for foreign stocks with

daily stock prices in local markets. For several foreign stocks that do not have local

stock prices available from EXTEL, we obtain the local data from the New York

Times. Among the 29 European stocks that meet the requirements, 21 are UK. For

convenience, we exclude non-UK European stocks so that the length of overlapping

trading hours on the NYSE and local exchanges is the same for European stocks.

Seven Asia-Paciﬁc stocks meet our selection requirements.

during the day. The diminishing effect of overnight information might explain why

the market activity surges at the open and declines afterward. This can be

illustrated by a simple regression model. Suppose V t , t denotes intraday market

activity (either trading volume or price movement) for interval

no variations once

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