Abstract
We study the tails of closing auction return distributions for a sample of liquid European stocks. We use the stochastic call auction model of Derksen et al. [1] to derive a relation between tail exponents of limit order placement distributions and tail exponents of the resulting closing auction return distribution and we verify this relation empirically. Counter-intuitively, large closing price fluctuations are typically not caused by large market orders, instead tails become heavier when market orders are removed. The model explains this by the observation that limit orders are submitted so as to counter existing market order imbalance.
Highlights
During the trading day, most securities change hands in continuous double auctions, in which buy and sell orders are immediately matched if possible
In this paper we study the tails of closing auction return distributions
We show that equation (2) is satisfied on average empirically, which is explained by the chronology of the closing auction: most of the market orders are submitted in the first seconds, revealing early in the auction the market order imbalance
Summary
Most securities change hands in continuous double auctions, in which buy and sell orders are immediately matched if possible. Nowadays it is widely recognized that distributions of (stock) price changes exhibit heavy tails: extreme price changes (of e.g. more than three standard deviations) are much more likely than in a Gaussian model or other models with exponentially decaying tails. This issue was first adressed by Mandelbrot (1963) in his analysis of cotton prices, where he proposed Levy stable distributions to model price fluctuations. Mike and Farmer (2008) propose a simulation based model for continuous trading, which suggests heavy tails in return distributions are caused by market microstructure effects, such as heavy tails in limit order placement and long memory in order flow. Bak et al (1997) and Cont and Bouchaud (2000) propose models linking heavy tails to herd behaviour
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
