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

Abstract

Option Shock was a notable 2010 manipulation in Korean stock and derivatives markets. Motivated by Option Shock, we examine the effectiveness of the conditional random‐end (RE) trading mechanism during the opening or closing call auction on the Korea Exchange. We find the conditional RE trading mechanism promotes price stabilization, but with some reservations, and improves price discovery and efficiency at the open, but causes overshooting at the close. We also find it somewhat effective in filtering out spoofing orders, but failed to stabilize the market in the extreme case of Option Shock, which motivated a change to an unconditional RE trading mechanism.

Dynamic and Static Volatility Interruptions: Evidence from the Korean Stock Markets

“…Here, noise is caused by liquidity shocks or price manipulation, and the closing call auction corrects the noise. This result is analogous to the price reversal surrounding the VI occurrence (Eom et al 2021).…”

“…Deutsche Börse Cash Market (2020) states that the Deutsche Börse (DB) introduced a RE mechanism to avoid manipulative orders. Eom et al (2021) show that the KRX RE mechanism helps to discourage spoofing at the open and close.…”

“…An RE trading mechanism is an integral part of a call auction mechanism. The ending time of the call auction is not fixed, but extended under certain circumstances for a brief randomly-chosen span of time less than or equal to a "maximum duration" such as 30 s or one minute (Eom et al 2021). Deutsche Börse Cash Market (2020) states that the Deutsche Börse (DB) introduced a RE mechanism to avoid manipulative orders.…”

“…The LULD is an extreme form of static VI, specifically focusing on preventing the recurrence of cases similar to the Flash Crash in 2010. It applies a rolling price limit to individual stocks, using price bands (5 or 10%) calculated over the previous five minutes trading (Eom et al 2021).…”

“…7 Eom et al (2021) analyze the (conditional) RE mechanism on the KRX, a built-in component of the VI, and show that its price-discovery effect could be different depending on trading session. 8 Broadly defined circuit breakers theoretically lead to a reduction in transactional risk (Greenwald and Stein 1991); stabilization of derivatives markets (Chowdhry and Nanda 1998); and the magnet effect whereby price limits become self-fulling (Subrahmanyam 1994).…”