Liquidity externalities and adverse selection: Evidence from trading after hours

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.