Switching to a Temporary Call Auction in Times of High Uncertainty

Abstract

We evaluate a stock specific circuit breaker mechanism implemented in several European stock exchanges, which consists of a short-lived call auction triggered by intraday stock-specific price limits. This switching mechanism differs from the previously studied US trading halts in that it is short-lived, non-discretionary, and there is always a trading mechanism (continuous or discrete) going. It differs from daily price limits in that trade prices are not restricted once the limit has been hit; moreover, the intraday price ranges are smaller and adjusted to the recent volatility of the stock, so that limit hits are more frequent. Using data from the Spanish Stock Exchange (SSE), we show that market conditions remain usually high no longer than 90 minutes after the resumption of the continuous session. Adverse selection costs are unusually high near the time of the limit hit, but they revert to normal levels in no longer than 30 minutes after the restart of continuous trading phase. Moreover, price patterns show continuations during the 5-minute auction period and strong reversals in the 30-minute interval following the resumption of the continuous session. Afterwards, prices stabilize. These price patterns suggest that limit hits in the SSE are mostly provoked by noise traders overreacting to new information. We also show that higher returns during the auction are both preceded and followed by more unstable market conditions and higher adverse selection costs, and lead to stronger post-auction price reversions. Our findings contribute to the debate about the benefits and drawbacks of circuit breakers by enlarging the span of these mechanisms studied so far.