Current Research in Market Microstructure

This document contains proprietary information of Viatris Inc. Unauthorized use, duplication, dissemination or disclosure to third parties is strictly prohibited.
© 2022 Viatris Inc. All Rights Reserved. VIATRIS and the Viatris Logo are trademarks of Mylan Inc., a Viatris company. The Pfizer Logo is a registered trademark of Pfizer Inc.
Research Article

• Title: Call auction design and closing price manipulation: Evidence from the Hong
Kong stock exchange. Journal of Financial Markets, 58, 100700.

• Authors: Suen, W., & Wan, K. M. (2022).

• Focus: Examining the closing call mechanism. “importance of call auction design
on closing price manipulation”
Research objective
• The Hong Kong Stock Exchange (HKEx) adopted a standard closing call auction
mechanism in 2008 but suspended its operation ten months later due to suspicion
of widespread price manipulation.

• The Exchange revamped the mechanism with manipulation-deterrence

enhancements and relaunched it in 2016. The article explores this unique setting
to examine the effect of call auction design on closing price manipulation.

• The results indicate that the standard call auction mechanism is vulnerable to
closing price manipulation. Under this mechanism, overnight price reversal is
more pronounced on days when derivatives expire and on days when large orders
were submitted just before the market close
Equity closing price is the most important price of the day
• Used to calculate the net asset values of mutual funds; (Chamberlain et al., 1989;
Stoll and Whaley, 1991).

• To determine settlement prices of derivatives contracts; (Kumar and Seppi, 1992;

Carhart et al., 2002).

• and to compute stock returns analyzed.

• Closing prices are prone to manipulation and can be distorted from fundamental
values (Felixson and Pelli, 1999; Hillion and Suominen, 2004; Spatt, 2014)
Status: Closing call mechanism

• In October 2018, closing call auctions were used in nine of the world’s top ten
stock exchanges by market capitalization,
• New York Stock Exchange (NYSE),
• Nasdaq,
• Tokyo Stock Exchange,
• Euronext, and
• London Stock Exchange group,
• with a combined market capitalization of approximately US$57 trillion, or 73% of
the world’s total value of equities.
Reasons for Closing call auctions
 It can facilitate trades at the market close eg rising popularity of passively
managed mutual funds ( see Appel et al., 2019)

 can absorb extreme liquidity shocks without producing inefficient prices and
excess volatility (Barclay et al., 2008).

 can improve price discovery (Madhavan, 1992; Biais et al., 1999; Cao et al., 2000;
Schwartz, 2001; Pagano and Schwartz, 2003; Comerton-Forde et al., 2007a;
Chang et al., 2008)

 it is widely believed that closing call auctions are more robust to manipulation than
other closing mechanisms (Hillion and Suominen, 2004; Comerton-Forde et al.,
2007a; Chang et al., 2008; Kadıo˘glu et al., 2015).
Background
 use a unique experience at the Hong Kong Stock Exchange (HKEx) to demonstrate the
importance of call auction design on closing price manipulation.

 On May 26, 2008, the HKEx changed its closing mechanism by introducing a standard
call auction mechanism (“StandardCALL”) which was conducted in a Closing Auction
Session (CAS) from 4:00 p.m. to 4:10 p.m.

 The introduction aimed to help institutional investors trade at securities’ closing prices
in a single-price call auction

 After five days after the introduction, excessive price movements occurred during the
closing session on the MSCI index rebalancing day.

 HKEx eventually suspended this mechanism due to extreme volatility and suspicion of
widespread price manipulation.
Example: HSBC Stock
Trading mechanisms
 HKEx has four trading sessions each day: pre-opening session, morning session (9:30
a.m. to 12:00 p.m.), afternoon session (1:00 p.m. to 4:00 p.m.), and closing auction
session.

 A call auction mechanism is used in the pre-opening to determine opening price

 lasts from 9:00 a.m. to 9:30 a.m. Continuous trading in an order-driven system
commences immediately after the pre-opening session

 4:00 p.m. to 4:10 p.m. and a call auction mechanism is used to determine the closing
price
Trading mechanisms: StandardCALL period

Standard call auction mechanism: StandardCALL period

 For approximately ten months from May 26, 2008 to March 22, 2009, the HKEx
introduced a standard call auction mechanism to determine closing price
 commenced at 4:00 p.m. and ended with a fixed closing time at 4:10 p.m.
 buy and sell orders set to determine the closing price would accumulate
 Traders could place, modify, and cancel market and limit orders during the first 8
min of the session.
 In the final 2-minute of the session, new market orders were allowed but
modification and cancellation of existing orders were disallowed
 Throughout the closing session, market participants could observe the resulting
indicative closing price and indicative trade volume, without any trades actually
taking place
 At 4:10 p.m., orders were matched, and transactions were executed at the
indicative closing price at 4:10 p.m., which was the closing price of the day.
Trading mechanisms: NonCALL period

Median pricing procedure: NonCALL period

 Starting in 1993, the HKEx used the median pricing procedure (NonCALL) to
compute the closing price.
 Closing price were determined by the median of five snapshot nominal prices in
the final minute of the afternoon session.
 These nominal prices are taken at five specific times, which are 15 seconds apart;
from 3:59 p.m. to 4:00 p.m. Choosing the median of these prices ensures that the
closing price would not be unduly influenced by one single trade.
 closing mechanism was replaced by the standard call auction mechanism on May
26, 2008. It was reinstated on March 23, 2009 after the standard call auction
mechanism was suspended and remained effective until the revamped call auction
mechanism was introduced on July 25, 2016.
Trading mechanisms: RevampCALL period

Revamped call auction mechanism: RevampCALL period

 the revamped call auction mechanism was introduced on July 25, 2016

 Includes two major enhancements: First, the closing time is randomized between 4:08 p.m. and
4:10 p.m. Second, the price limit is significantly reduced to only ±5% of the reference price set at
4:00 p.m.

 The reference price is also improved and determined by the median of five nominal prices taken
in the final minute of the afternoon session rather than a single nominal price taken at 4:00 p.m.
used in the standard call auction mechanism.

 Other minor enhancements include no modification and cancellation of existing orders during the
final 4-minute of the closing session.

 Limit orders are allowed throughout the entire closing session. Other design features are
identical to those used in the standard call auction mechanism.
Benchmark case
Sell Side
Buy side
Aggressive Limit Sell Side
Benchmark case