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SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

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Appendix 2: Open-To-Close vs. Overnight Volatility<br />

This Appendix addresses the question of how high is volatility during trading hours<br />

compared to the volatility when the market is closed, as reflected in the overnight return.<br />

To address this question, we observed the S&P 500 futures price immediately after 9:30<br />

AM and immediately prior to 4:00 each day. For each day t, we computed the overnight<br />

return from 4:00 on day t-1 to 9:30 on day t (Rto) and the open-to-close return on day t<br />

(Rtd). We then computed the ratio of the squared open-to-close return to the sum of the<br />

two squared returns. This represents the relative contribution of the open-to-close return<br />

to total variance, denoted OCV:<br />

2<br />

Rtd<br />

OCV = .<br />

R + R<br />

In the extreme case where all price changes occur between 9:30 and 4:00 and the<br />

overnight return is always zero, the OC metric would equal one. In the opposite case<br />

where the price always remains constant between 9:30 and 4:00 and all price changes<br />

occur overnight, the OC metric would equal zero. The metric was computed each day<br />

then aggregated across days for each quarter from 1986 to 2008.<br />

As indicated in Figure 11, the Open-to-Close Return typically represented around 60-<br />

70% of total variance, with a slight downward trend over time.<br />

Focusing on those quarters having abnormally high end-of-day volatility, some of these<br />

quarters also had a low value for OCVs. In other words, during time periods that<br />

experienced market turbulence, relatively more volatility occurred overnight. For<br />

example, Figure 11 shows that Q4 of 1987, Q4 of 1997, and Q3 and Q4 of 2007 had<br />

relatively low values of OCV. However, the OCV metric was not particularly low for Q3<br />

or Q4 of 2008.<br />

15<br />

2<br />

to<br />

2<br />

td<br />

DRAFT: Produced by <strong>OEA</strong><br />

<strong>SEC</strong>_<strong>OEA</strong>_<strong>FCIC</strong>_001816

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