Low-Latency Trading and Price Discovery Without Trading: Evidence from The Tokyo Stock Exchange Pre-Opening Period

Abstract

We study whether the presence of low-latency traders (including high-frequency traders (HFTs)) in the pre-opening period contributes to price discovery in the subsequent opening call auction and the continuous trading session. Our analysis evokes shades of the debate on the switch from the current continuous auction in many markets to a periodic auction, affecting the speed advantage of low-latency traders. We empirically investigate these questions using a unique dataset based on server IDs provided by the Tokyo Stock Exchange (TSE), one of the largest stock markets in the world. Our data allow us to develop a more comprehensive classification of traders than in the prior literature, and to investigate the behavior of the different categories of traders, based on their capability for low-latency trading. We find that, perhaps due to the lack of immediate execution, about three quarters of the low-latency traders do not participate in the pre-opening period, but do participate in and dominate the continuous trading session. Furthermore, we find that the larger presence of low-latency traders in the trading of a stock in the pre-opening period as well as in the continuous session improves the price discovery process. Our results suggest that HFTs may not participate in trading in the periodic batch auction because of a lack of immediate execution, and that this large reduction in HFT participation may impede the quality of price discovery.