Realized Volatility and Overnight Returns

Abstract

No consensus has emerged on how to deal with overnight returns when calculating realized volatility in markets where trading does not take place 24 hours a day. This paper explores several common volatility applications, investigating how the chosen treatment of overnight returns affects the results. For example, the selection of the best volatility forecasting model depends on the way overnight returns are incorporated into realized volatility. The evidence favours weighted estimators over those that have been more commonly used in the existing literature. The definition of overnight returns is particularly challenging for the S&P 500 index, and we propose two alternative measures for its overnight return.?