Christopher Polk (London School of Economics)

The Day Destroys the Night, Night Extends the Day: A Clientele Perspective on Equity Premium Variation

Abstract. We decompose market returns into their overnight and intraday components, which dramatically improves equity premium forecasts. Past smoothed overnight market returns strongly negatively forecast subsequent close-to-close returns (quarterly R² of over 14%), primarily through intraday mean reversion. In contrast, past smoothed intraday market returns strongly positively forecast subsequent overnight returns; this partially-offsetting effect explains PE’s relatively poor forecasting ability (R² only 3%). Our decomposition also resurrects the conditional CAPM: If we allow market betas to vary with past smoothed overnight returns, the four Fama-French factors’ alphas decrease on average by 84%. We interpret these return patterns through a clientele perspective. First, individual investor expectations and consumption growth strongly positively forecast overnight market returns, while intermediary risk tolerance strongly negatively forecasts intraday market returns. Second, aggregate cash-flow news occurs primarily intraday and is positively (negatively) correlated with revisions in expected future overnight (intraday) returns. Finally, while the Tech boom, Covid crash/rebound, and patterns in meme stocks were primarily driven by overnight returns, the Global Financial Crisis was mostly an intraday phenomenon.