Is Risk Higher During Non-Trading Periods? Tail Risk Evidence from Overnight Market Returns

We study the magnitude of tail risk --- particularly lower tail downside risk --- that is present in intraday versus overnight market returns and thereby examine the nature of the respective market risk borne by market participants. Using the Generalized Pareto Distribution for the return innovations, we use a GARCH model for the conditional market return components of major stock markets covering the U.S., France, Germany and Japan. Testing for fat-tails and tail index equality, we find that overnight return innovations exhibit significant tail risk, while intraday innovations do not. We illustrate this volatility versus tail risk trade-off based on conditional Value-at-Risk calculations. Our results show that overnight downside market risk is composed of a moderate volatility risk component and a significant tail risk component. We conclude that market participants face different intraday versus overnight risk profiles and that a risk assessment based on volatility only will severely underestimate overnight downside risk.