Liquidity Externalities and Adverse Selection: Evidence from Trading after Hours


  • Michael J. Barclay,

  • Terrence Hendershott

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    • Barclay and Hendershott are from the Simon School of Business, University of Rochester and Haas School of Business, University of California at Berkeley. We thank Tim McCormick for providing data and helpful comments. We also thank Rick Green (the editor); Joel Hasbrouck; Rich Lyons; an anonymous referee; and seminar participants at the Review of Financial Studies Conference on Investments in Imperfect Capital Markets, the University of California at Berkeley, the University of North Carolina, and the Economic Research group at Nasdaq for their helpful comments. Hendershott gratefully acknowledges support from the National Science Foundation. Any errors are our own.


This paper examines liquidity externalities by analyzing trading costs after hours. There is less than 1/20 as many trades per unit time after hours as during the trading day. The reduced trading activity results in substantially higher trading costs: quoted and effective spreads are three to four times larger than during the trading day. The higher spreads reflect greater adverse selection and order persistence, but not higher dealer profits. Because liquidity provision remains competitive after hours, the greater adverse selection and higher trading costs provide a direct measure of the magnitude of the liquidity externalities generated during the trading day.