Order Consolidation, Price Efficiency, and Extreme Liquidity Shocks

Abstract

We show that the consolidation of orders is important for producing efficient prices, especially during times of high liquidity demand. The NYSE's centralized opening call market performs better than Nasdaq's decentralized opening process on typical trading days. The NYSE is much better than Nasdaq on witching days when index arbitrage activity subjects S&P 500 stocks to large, predictable, and mostly informationless order flow around quarterly futures contract expirations. Nasdaq opening price efficiency improves to NYSE levels once Nasdaq initiates a consolidated opening call in November 2004, but prices on the decentralized Nasdaq remain less efficient at other times of day.

Closing Call Auctions at the Index Futures Market

“…In this way, the CCA improves price discovery (Schwartz, 2001), reduces information asymmetry problems (Madhavan, 1992), and improves the market's ability to absorb liquidity shocks (Economides & Schwartz, 1995;Pagano & Schwartz, 2003;Barclay, Hendershott, & Jones, 2008). A CCA collects limit orders over a specified time interval after the continuous trading session and executes matching orders in one trade, where this last trade's price often represents the reference closing price.…”

Non-Fundamental Information and Market-Makers' Behavior During the NASDAQ Preopening Session

“…8 Despite the absence of any obligation to post quotes, and very few volume of transactions (on average, less than 0.5% of the total daily trading volume, and less than 0.25% of the total daily number of trades), the preopening period was very active, as illustrated by the amount of preopening quotes in my sample (on average 10.25% of the daily total number of inside quotes occurred during the preopening session, going up to a maximum of 84%). 9 Following this preopening period, mandatory trading hours started at 9:30 am without any formal mechanism for price discovery. The NASDAQ opening was a complete decentralized process until the implementation of an electronic call auction, referred as Among nonbinding quotes, crossed and locked inside quotes have been found to convey credible information.…”

Non-Fundamental Information and Market-Makers' Behavior During the NASDAQ Preopening Session

“…10 My paper investigates whether dealers did post quotes that generated crossed and locked markets in order to signal 8 The minimum quantity that dealers had to display during trading hours was 1,000 shares for stocks in sample at the time of my analysis. 9 As established by , I use trades marked in TAQ with a "T" designator to determine the trading volume and the number of trades executed during the preopen from Oct. 1995 to Sept. 1996.…”

“…TAQ quotes are anonymous, and time-stamped to the nearest second. I omit quotes with non-positive depth, quotes for which either the ask or bid price is non-positive, and quotes for which TAQ's MODE codes 4,7,9,11,13,14,15,19,20,27, and 28. For trades, I drop trades coded as involving an error or a correction (TAQ's CORR field is greater or equal to 2).…”

“…In comparison, the market is crossed/locked on average 28 days during the mandatory trading session. Over the period, the number of preopening quotes ranges from 1,831 to 30,280, with a median of 9,193. The number of crossed/locked markets is much less frequent with a median of 146, ranging from 6 to 1,324.…”