Overnight Returns as a Market Timing Strategy

Risk-adjusted overnight returns greatly exceed risk-adjusted daytime returns. Researchers use Jensen's alpha or the Fama-French three factor model for risk adjustment and use Fama-MacBeth regressions to test the estimated betas' predictivity. However, owning stocks only during the day or night is a market timing strategy. Using the non-linear factors proposed by Merton (1981) and Goetzmann et al. (2000), we show that the close-to-open strategy has negative market timing ability (measured by a non-linear regressor) with a positive selectivity alpha (measured by alpha), while the open-to-close strategy has the opposite. We also find that alpha is significant in down market periods