London Stock Exchange call-auction no longer effective, says Business School research

The London Stock Exchange’s (LSE) opening call auction may need to be rethought after research finds it regularly fails to set efficient prices for more than 80% of FTSE 100.

In the most comprehensive study of its kind, academics from University of Edinburgh Business School found the LSE’s opening auction regularly fails to efficiently price more than 80% of the highest volume stocks on the market.

Researchers analysed close to 74 million individual trades* of FTSE 100 stocks during a 12 month period between 2012 and 2013.

The combined FTSE 100 stocks in the sample average a total trading value of more than £21.54 billion and 290,000 transactions per day.

The findings come as the LSE looks to counter dark pools and other alternative equity exchange venues with the introduction of a midday intraday auction.

During the ten minute window between the call auction starting at 7.50am, and the market opening at 8am, the research also found a significant lull in trading activity for the majority of stocks. Only in the last 60 seconds of the window was significant activity observed.

The call auction was found to be almost entirely ineffective for setting the price of lower volume stocks in the FTSE 100, as traders avoid trading in a highly informed trading environment and chose instead to wait until the market opens.

Meanwhile the pre-open for these stocks was also found not to reveal all overnight information for lower volume stocks.

Dr Gbenga Ibikunle, Lecturer in Financial Markets at University of Edinburgh Business School, led the research. He said:

“Our study suggests the influence of the call auction may have been exaggerated and oversold to investors by trading platforms eager to please the market.

“When the opening auction was introduced to the LSE in 1997, it had two clear advantages.

“Firstly it offered more transparency, since all order details are released to the market once placed. And secondly, by drawing all orders in before auction it also provided a higher level of liquidity in the market, which increased the likelihood of filling orders.

“However, in an era when high frequency trading is pre-eminent and alternative equity exchanges have democratised market information substantially, it is no longer suited to fulfilling either purpose.

“Our findings suggest it may be time for the LSE to reconsider the value of the opening call auction.

“Without a period of continuous trading preceding it – as is the case with the closing auction – the mechanism is of little use in establishing efficient prices.”

The research was published in the Journal of International Financial Markets, Institutions and Money Volume 34.

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