Nasdaq’s Closing Cross: Has Its New Call Auction Given Nasdaq Better Closing Prices? Early Findings

Abstract

On March 29, 2004, Nasdaq significantly expanded its hybrid market structure by introducing the Closing Cross, an electronic price discovery call auction that sets closing trades and establishes official closing prices. Three months later, on June 25, the efficiency of the new facility was stress tested by the Russell 2000 rebalancing, an event that involved almost 1,700 Nasdaq stocks. We analyze the efficiency of the Closing Cross by contrasting price dislocations experienced at the 2004 rebalancing with those observed at the 2003 rebalancing. By and large, the findings suggest that the closing procedure was effective, especially for smaller cap stocks in the Russell 2000 index. Nasdaq’s Closing Cross: Early Findings On March 29, 2004, the Nasdaq Stock Market expanded its hybrid market structure by introducing a price discovery call auction into its trading system. The call is run daily at 4:00 pm to close Nasdaq’s normal trading day. Nasdaq refers to it as “Closing Cross,” but the facility is in fact a call auction because it provides price discovery. In this paper, we assess the impact that the call has had on Nasdaq’s official closing prices. The assessment should be considered preliminary because relatively little time has passed since the call has been instituted. Time is required for participants to learn how best to use any new system, and for sufficient data to be generated for a more complete analysis. Nevertheless, we have undertaken this early assessment in view of the importance of the innovation. A call auction differs from continuous trading in the following way. In a continuous market, a trade is made whenever a bid and offer match or cross each other in price. In a call auction, the buy and sell orders are cumulated for each stock for simultaneous execution in a multilateral, batched trade, at a single price, at a predetermined time. By consolidating liquidity at specific times, a call auction is intended to reduce execution costs for individual participants, and to sharpen the accuracy of price discovery for the broad market. Closing call auctions were introduced in Europe (including London, Paris, and Germany) specifically because of customer demands for improved price discovery at 1 We are grateful to Frank Hatheway and Tim McCormick for their insights and factual information that they have provided us. We also thank Yakov Amihud, Corinne Bronfman, Lin Peng, George Sofianos, and Steve Wunsch for their very helpful comments. 2 In contrast, crossing networks such as ITG’s Posit and Instinet’s after hours cross, do not provide price discovery. Rather, they match crossing buy and sell orders at a price (either the mid-point of a stock’s bidask spread or a stock’s closing transaction price) that is set in a major market center. 3 For additional discussion and further references, see Economides and Schwartz (1995), and Schwartz and Francioni (2004).