Risky short positions and investor sentiment: Evidence from the weekend effect in futures markets

• Author: Vijay Singal,Jitendra Tayal
• DOI: http://doi.org/10.1002/fut.22069
• Date: 01 March 2020
• Published date: 01 March 2020

J Futures Markets. 2020;40:479–500. wileyonlinelibrary.com/journal/fut © 2019 Wiley Periodicals, Inc.

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479

Received: 24 October 2018

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Accepted: 11 October 2019

DOI: 10.1002/fut.22069

RESEARCH ARTICLE

Risky short positions and investor sentiment: Evidence

from the weekend effect in futures markets

Vijay Singal

1

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Jitendra Tayal

2

1

Department of Finance, Pamplin College

of Business, Virginia Tech, Blacksburg,

Virginia

2

Department of Finance, College of

Business, Ohio University, Athens, Ohio

Correspondence

Jitendra Tayal, Department of Finance,

College of Business, Ohio University,

CBA 202B, Athens, OH 45701.

Email: tayal@ohio.edu

Abstract

This paper examines the weekend effect in futures markets and presents rational

and behavioral reasons for its existence. Specifically, we document a weekend

effect (Friday’s return minus the following Monday’s return) in futures markets.

The weekend effect occurs partly because of asymmetric risk between long and

short positions around weekends; the weekend effect increases when short

positions are relatively more risky. In addition, we find that both lagged and

contemporaneous changes in investor sentiment are related to the weekend

effect. These results are consistent with the investor sentiment literature that

finds that mood improves on Fridays but deteriorates on Mondays.

KEYWORDS

asymmetric risk, futures markets, investor sentiment, short selling, weekend effect

JEL CLASSIFICATION

G14; G23

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INTRODUCTION

Extensive research has documented different return seasonalities in a wide variety of markets. Results from these

studies suggest the existence of weekend, January, and turn‐of‐the‐year effects.

1

However, similar investigations in the

futures markets are few and focus on a small number of asset classes.

2

In this paper, we focus on one such seasonality,

that is, the weekend effect, which is defined as Friday’s return minus following Monday’s return (Chen & Singal, 2003)

in the futures markets. Specifically, we empirically examine the existence of the weekend effect in futures markets and

present potential reasons for its existence.

We propose two competing hypotheses as potential explanations for the existence of a weekend effect in futures

markets. Our first hypothesis presents a risk‐based explanation that relies on two distinct notions of variances, that is,

bad and good variations in asset returns. Following Barndorff‐Nielsen and Shephard (2004), we decompose realized

variance into good and bad realized semivariances and implement these as proxies for upside and downside risk,

respectively. Higher upside realized semivariance is a risk for short positions, and higher downside semivariance is a

risk for long positions. Therefore, we expect the weekend effect to be higher when relative risk for short positions is

higher than that of long positions because of asymmetric risk premia associated with short positions.

The second hypothesis is motivated from the psychology literature on investor sentiment/mood.

3

An important

finding in this literature is that investor mood varies with day of the week. Especially, investor mood worsens on

1

See Cross (1973), French (1980), Gibbons and Hess (1981), Keim (1983), Harris (1986), Lakonishok and Smidt (1988), Kamstra, Kramer, and Levi (2003), and among others.

2

See Section 2 for review of the literature on weekend effect in futures markets.

3

We use investor sentiment and investor mood interchangeably.

Mondays and improves on Fridays. This variation in investor mood has an impact on decision making when

information is uncertain (Clore, Schwarz, & Conway, 1994; Forgas, 1995; Hegtvedt & Parris, 2014). Similar

contemporaneous effects are documented in equity markets where change in investor sentiment impacts stocks returns

(Baker & Wurgler, 2006; Birru, 2018). Given the impact of investor sentiment on stock returns, we expect to see an

impact of aggregate investor sentiment on the weekend effect in futures markets as well.

We begin our analysis by selecting major futures contracts and categorizing them in seven asset classes:

energy futures, grains futures, softs futures, equity futures, currency futures, bond futures, and metals futures.

Onthebasisofthemostactivenear‐month contracts, we find that the weekend effect is statistically and

economically significant in energy futures with gasoline futures displaying a return of 0.42%, followed by Brent

crude oil and West Texas Intermediate (WTI) crude oil. As mentioned above, we implement an empirical

framework for computation of risk associated with long and short positions based on historical returns and

apply these risk measures to futures markets. As expected, the weekend effect is concentrated during weeks

when the risk of short position relative to long position (Ratio)

4

is higher. For instance, Friday minus Monday

return for gasoline futures is 0.77% when Ratio > 1 and is statistically insignificant when Ratio ≤1. These results

confirm our hypothesis that relative risk of short position over long position is one of the key reasons driving

the weekend effect.

Next, we analyze changes in investor sentiment across different days of the week using Volatility Index (VIX;

investor fear gauge) as a measure of investor sentiment (Baker & Wurgler, 2007). Following Birru (2018), we report that

average change in VIX (ΔVIX) is highest (2.16%) on Mondays and lowest (−0.69%) on Fridays. These changes in VIX are

consistent with investor sentiment being highest on Fridays and lowest on Mondays. Furthermore, our results show a

significant correlation between contemporaneous changes in investor sentiment over the weekend and the weekend

effect in futures markets. Energy and equity futures display a significant weekend effect (1.285% for gasoline futures) for

the quintile when ΔVIX is highest over the weekend. Birru (2018) argues that when investors are fearful, they migrate to

safer assets, like the Treasury market. The weekend effect in bond futures displays these effects, which are opposite of

the weekend effect in equity futures. We also find that lagged changes in investor sentiment correctly predict the

direction of the weekend effect.

The above results support both rational and behavioral explanations for the weekend effect. A natural question

that follows from these results is whether one explanation subsumes the other. Therefore, we examine the impact

of change in investor sentiment on the weekend effect by subcategorizing them based on their asymmetric risk.

The results show that both explanations hold for the weekend effect and are not proxies for one another.

Specifically, the results are concentrated in subgroup with Ratio >1 within the highest quintile of ΔVIX for energy

futures. Furthermore, regression results show that symmetric risk and investor sentiment are both independently

significant.

Finally, in addition to asymmetric risk measures based absolute returns, we estimate an adjusted asymmetric

measure based on abnormal returns to account for different market conditions. Using this asymmetric risk measure, we

categorize futures contracts into two groups. Consistent with our prior results, the weekend effect is concentrated

during weeks when the adjusted risk of short position relative to long position (AdjRatio)

5

is higher.

This paper makes several contributions to the literature on the weekend effect in futures markets. First, we present

an expansive analysis of the existence/absence of the weekend effect in major futures contracts across seven asset

classes. Second, we implement a model‐free asymmetric risk measure to quantify the risk associated with short and

long positions and find that this relative risk measure is one of the predictors for existence of a weekend effect in futures

markets. Third, we examine an alternative explanation based on investor sentiment that, we find, also contributes to a

lower Monday average return in the futures markets. Our results show a stronger weekend effect for futures contracts

with higher relative risk for short positions during periods of larger changes in investor sentiment. Overall, our results

document the presence of a weekend effect in futures markets and show that both rational and behavioral factors are

related to the observed patterns.

Rest of the paper is organized as follows. Section 2 presents a brief literature review on the weekend effect followed

by a discussion of the two likely explanations considered in this paper. Section 3 covers data sources and sample

characteristics. Section 4 discusses the empirical analysis and results. Section 5 concludes.

4

Please refer to Section 2.2.1 for computation of Ratio.

5

Please refer to Section 2.2.1 for computation of AdjRatio.

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SINGAL AND TAYAL