Study Suggests Markets Operate More Smoothly Without Open Exchange Floors

Chris Gaetano
Published Date:
May 21, 2020

While the New York Stock Exchange is planning to reopen its trading floors after memorial Day, a recent study says that markets actually operated a lot more smoothly when the trading floors were closed. The study, authored by law and finance professors from NYU and the University of Chicago, looked specifically at the quality of the 4 p.m. closing auctions that determine stock prices at the end of the trading session. While some exchanges, such as the Nasdaq, conduct theirs fully electronically, the NYSE uses a hybrid system in which 35 percent of orders are entered manually by floor traders, the type who will soon be returning to the exchange floor in limited numbers at the end of the month. This, said the study, affords special advantages to those physically at the exchange.

"One advantage is that they are allowed to enter or cancel their orders (also called “D-Orders”) after the cutoff time of 3:50 pm for regular orders. A second advantage is that publicly-disseminated auction information such as the indicative closing price does not incorporate floor brokers’ orders until 3:55 pm. Thus, most ordinary investors remain in the dark about true auction interest until 3:55 pm, which is five minutes after the cutoff time for submitting regular orders to the auction," said the paper.

The researchers compared closing auction quality between the NYSE and the Nasdaq both before and after the former shut down its trading floor. The study defined closing auction quality as "the accuracy of indicative closing auction prices and matched volume relative to their realized values at 4:00 pm, and the size of indicative order imbalances relative to matched volume."

Prior to the closures, the researchers said that quality was much lower on the NYSE than on the Nasdaq. Just before 3:55 p.m. on the NYSE, closing prices were found to be off by about 100 basis points, indicative matched volume was 42 percent lower than realized match volume, and indicative absolute order imbalance was 51 percent of matched volume. In contrast, the Nasdaq's 3:55 p.m. found closing prices were off by 12 basis points, indicative matched volume was 3 percent lower than realized matched volume, and indicative absolute order imbalance was 3 percent of matched volume.

"Put another way, the indicative statistics reported by NYSE before 3:55 pm do not accurately indicate what will eventually happen when the auction clears at 4:00 pm," said the study. The researchers said this indicates that floor brokers "opportunistically take $5.3 million in liquidity on each stock-day."

On the other hand, once the exchange floor closed and the NYSE went fully digital, the researchers found that "indicative matched volume on NYSE at 3:55 pm jumps significantly from 46 percent to 74 percent of final auction volume" which means that "the majority of auction orders are matched shortly after the cutoff time for regular auction orders once the floor closes, much like on Nasdaq." It also found that "the absolute difference between the indicative closing auction price at 3:55 pm and the final closing auction price decreases by about 106 basis points." Finally, the "ratio of absolute order imbalance to matched volume decreases by 6 percentage points" compared to the Nasdaq, which had virtually no change.

The researchers believe these changes can be attributed to the NYSE closing auction switching to a one-period auction in which all participants directly compete with each other at the same time, rather than floor traders being able to press advantages over those not physically there.

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