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1 November 2013 CFA Institute Journal Review

The Effect of US Holidays on the European Markets: When the Cat’s Away… (Digest Summary)

  1. Robert H. Kaplan

Anomalous positive returns are evident in European equity markets during NYSE holidays. The anomaly is particularly significant when the daily NYSE return preceding the holiday is positive. The authors conclude that the probable causes of the anomaly are fewer economic news releases and reduced participation of sophisticated U.S. institutional investors during the holiday.

What’s Inside?

The authors statistically examine the returns of the French CAC 40, German DAX 30, EURO STOXX 50, and United Kingdom FTSE 100 equity indices on days that coincide with NYSE holidays. When the NYSE holiday is preceded by a day when the NYSE daily return is positive, the European equity indices have an average return 15 times larger than normal and with lower volatility. Additional statistical tests reveal that this aberration cannot be explained by previously published behavioral anomalies in the existing financial academic literature. The reduced frequency of macroeconomic news and changing investor mix that accompany NYSE holidays are probable causes of the return effect.

How Is This Research Useful to Practitioners?

The identification of specific days that have statistically significant excess equity returns and volatility, across bullish and bearish market phases, would be of great interest to equity and equity derivatives investors, traders, and portfolio managers participating in European markets.

The authors demonstrate that statistically significant and economically exploitable excess returns in the European equity markets coincide with NYSE holidays. The effect is particularly significant when the daily NYSE return preceding the holiday is positive. The authors quantify the economic value of the anomaly by backtesting a trading strategy using historical European equity futures contract data. The returns of the backtest are positive and exceed transaction costs by a wide margin for each equity index examined during the test period.

The anomaly could be the result of a change in the investor mix in European markets during U.S. trading holidays. Because U.S. institutional investors do not participate in their typical numbers during NYSE holidays, a greater proportion of less sophisticated “noise traders” are represented in the market, which the authors suggest could lead to higher equity returns.

The other potential cause of the anomaly is the reduced flow of macroeconomic information on NYSE holidays. Because European stock markets will not incur the uncertainty surrounding the NYSE open or U.S. macroeconomic news releases, the authors submit that a belief in the last known economic data will persist—the same data that presumably caused a positive daily return preceding the holiday—and will result in continued bullish momentum.

How Did the Authors Conduct This Research?

The authors use Datastream historical index opening and closing price data for the period from 1991 to 2008 for the French CAC 40, German DAX 30, European Union EURO STOXX 50, United Kingdom FTSE 100, and Spanish IBEX 35. Closing futures price data are taken from Bloomberg for these same indices. The sample length for each index varies depending on data availability. Using these price data, the authors calculate the daily log returns for close-to-close, close-to-open, and open-to-close intervals, as well as the percentage of days with positive and negative returns and the return deviation for holidays and nonholidays.

The daily log returns for each interval for the entire sample period are calculated and compared with the returns for the days that coincide with NYSE holidays. The authors note the intraday excess return anomaly in conjunction with the strong predictive influence of the NYSE daily return on the day preceding the holiday.

They acknowledge the challenge to the efficient market hypothesis that this anomaly introduces. In addition, they apply deductive logic and perform additional statistical tests that allow for control variables to examine (and discard) alternative explanations attributable to such previously discovered behavioral anomalies as the January effect, preholiday effect, and day-of-the-week effect. The evidence indicates the discovery of a new anomaly.

Abstractor’s Viewpoint

This article is an interesting and valuable contribution to behavioral finance in the areas of equity returns and volatility forecasting. The supporting quantitative analysis is accessible to most investment practitioners, and the methods provide a template other researchers can build on. Continued areas of research in this genre include examination of whether the implied volatility of European equity options incorporates the unusually high volatility on NYSE holidays, whether bond markets demonstrate similar anomalous return patterns, and whether non-European markets exhibit similar behavioral patterns surrounding NYSE holidays.

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