Shifting Volumes to the Close: Consequences for Price Discovery and Market Quality

Abstract

Due to the rise in passive investments and regulatory changes, equity markets worldwide have witnessed substantial shifts of trading volumes to the close. Based on three major European markets, where closing auctions account for more than one third of daily trading volume, we analyze whether such high-volume closing auctions have negative implications for price discovery at the close and market quality during continuous trading. We find evidence for significant distortions of the closing price with 14% of the closing auction return being systematically reversed overnight. Increasing closing auction volumes, index rebalancing days, and high intraday returns are the main drivers of these reversals. Our results also show that intraday liquidity decreases due to the shift of trading volumes to the close while volatility improves. Thus, our findings on the effects of high-volume closing auctions are in contrast to the positive effects of closing auctions for price discovery and liquidity predicted by theory.

Keywords: Closing Auction, Passive Investing, Price Efficiency, Liquidity, volatility