Callable bull/bear contracts, call auction sessions, and price manipulations: Evidence from Hong Kong

Abstract

Call auction sessions are widely adopted to improve the price discovery process. The suspension of the closing call auction session (CAS) of the Hong Kong Stock Exchange (HKEx) in 2009 and the reintroduction of an enhanced CAS in 2016 provide us a unique experimental environment to assess the effectiveness of the two different CAS models in reducing market manipulation. In examining the probability of mandatory call events (MCEs) of callable bull/bear contracts (CBBCs), we find the enhanced CAS model being more effective in price manipulation reduction. We also find the enhanced CAS reducing price manipulation in the preopening auction session.

Effectiveness of the conditional random‐end trading mechanism on the Korea Exchange: Normal trade and Option Shock

“…Now, we discuss the research on the effectiveness of RE trading mechanisms against manipulative attempts connected to derivatives trading at the close. In a paper with similar research objectives to ours, Lei et al (2020) report that an RE feature in the closing call auction in the HKEx reduces price manipulation connected to a derivative product. In the HKEx, the closing call auction was first implemented in May 2008 but removed in March 2009.…”

“…He directly examines the RE trading mechanism itself, but only during volatility interruptions (which incorporate call auctions with an RE trading mechanism) occurring during continuous trading sessions, using cross‐sectional methods. In addition, he does not discuss the potential manipulative trading in stock markets associated with derivatives markets while Option Shock and the literature (Lei et al, 2020) imply that it is likely to happen. Guillaumie et al (2020) make the first attempt for the efficacy of volatility interruptions in cross‐listed stocks.…”

“…Then, it was reintroduced in an enhanced version in July 2016. Lei et al (2020) note that the enhanced version has many refinements including an RE (random closing), appearing to be more effective in the reduction of price manipulation. The extreme distances of RE trading mechanisms in the HKEx and KRX are both set to 5%, but the extreme event such as Option Shock suggests that RE trading mechanisms may be vulnerable to such events despite Lei et al's (2020) findings.…”

“…The extensive literature on the call auction mechanism in general has documented that it improves price discovery and the market's ability to absorb liquidity shocks, and reduces information asymmetry problems and price manipulation (Comerton‐Forde & Rydge, 2006; Hagströmer & Nordén, 2014; Hillion & Suominen, 2004; Lei et al, 2020; Madhavan, 1992; Pagano & Schwartz, 2003). However, most of this literature does not investigate either the built‐in RE component or its effectiveness against price manipulation operating between spot and derivatives markets.…”

“…To our knowledge, no paper addressed the effectiveness of RE mechanisms on manipulative attempts connected to derivatives trading. Lei et al (2020) examine the effectiveness of the closing call auction in the Hong Kong Stock Exchange (HKEx), focusing on the underlying stocks of exchange‐traded derivatives (callable bull/bear contracts). However, they cannot separately examine the roles and functions of RE mechanisms because they use daily data.…”