A Two-Stage Non Discretionary Trading Suspension Mechanism: Effects on Market Quality

This paper investigates the intraday effects on market quality of a unique trading suspension mechanism in place at the Italian stock market (Borsa Italiana) in case of price limit hit. Specifically, when prices hit the limit, Borsa Italiana halts trading for 5 minutes ('freeze phase') and removes the order that caused the limit to be hit. If trading regularly resumes after the freeze phase, exchange officials make no other intervention and we call this sequence of events 'Type 1' halt (i.e., freeze-only halt). Alternatively, if a second limit hit occurs after the freeze phase, an intraday call auction replaces the continuous trading. We name this sequence 'Type 2' halt (i.e., intraday auction halt). We examine both the general effects of trading halts and the specific effects of Type 1 and Type 2 trading suspensions on three dimensions of market quality: trading activity, return volatility, and price discovery. The full sample results reveal mixed evidence about the usefulness of price limit hit trading halts: trading volume and return volatility after the halt are abnormally high (trading interference hypothesis for volume and spillover hypothesis for volatility), whereas prices converge towards equilibrium values (cool off hypothesis for price discovery). When we partition the sample by type of halt three main results arise. First, Type 2 halts always show larger abnormal volume measures than Type 1 and this indicates a greater interference on the normal trading process of Type 2 relative to Type 1 halts. Second, Type 2 halts show lower post-halt abnormal volatility than Type 1. This might be explained by the difference in the way the market restarts after the halt. The call auction procedure associated with Type 2 allows for wider information dissemination, whereas the price discovery process in Type 1 trading halts takes place only through the tâtonnement process in continuous trading. Third, for the price discovery process, the call auction reopening procedure of Type 2 halts also has a stronger cool off effect relative to the Type 1 continuous trading