Market Design and the Efficiency of a Stock Market Under Liquidity Stress

66 Pages Posted: 21 Mar 2009

See all articles by Shmuel Hauser

Shmuel Hauser

Ben-Gurion University of the Negev - School of Management; Government of the State of Israel - Israel Securities Authority

Itzhak Shurki

Israel Securities Authority

Avraham Kamara

University of Washington - Michael G. Foster School of Business

Date Written: March 18, 2009

Abstract

Stock exchanges around the world are challenged by extreme liquidity events. We examine how trading design affects the informational efficiency of markets under liquidity stress due to opening of trade and the expiration of stock index derivatives. To give markets time to incorporate overnight and weekend information efficiently, most exchanges open trading using a preopening period followed by a call auction. To further improve their ability to accommodate extreme liquidity events exchanges have switched from fixed to random opening times. We investigate the effects of opening time randomization on informational efficiency of opening and preopening stock prices on stock index options expiration days and other days. Randomization has significantly improved price discovery and reduced transitory volatility and price distortion, especially on index options expiration days. Randomization offers exchanges a simple and effective way to mitigate stressful effects of extreme liquidity events. It also helps traders settle their options positions using prices that are closer to their true values, which improves the hedging effectiveness and price discovery provided by options.

Keywords: Market design, preopening and opening prices, informational efficiency, options expirations, manipulation, international equity market

JEL Classification: G14, G15, G19

Suggested Citation

Hauser, Shmuel and Shurki, Itzhak and Kamara, Avraham, Market Design and the Efficiency of a Stock Market Under Liquidity Stress (March 18, 2009). Available at SSRN: https://ssrn.com/abstract=1364451 or http://dx.doi.org/10.2139/ssrn.1364451

Shmuel Hauser

Ben-Gurion University of the Negev - School of Management ( email )

P.O. Box 653
Beer-Sheva 84105
Israel
+972 2 651 3939 (Phone)
+972 7 6472896 (Fax)

Government of the State of Israel - Israel Securities Authority

22 Kanfei Nesharim Street
Jerusalem 95464
Israel

Itzhak Shurki

Israel Securities Authority ( email )

Jerusalem 91341
Israel

Avraham Kamara (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States
206-543-0652 (Phone)
206-221-6856 (Fax)

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