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

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