Pre-Close Transparency and Price Efficiency at Market Closing: Evidence from the Taiwan Stock Exchange

ABSTRACTThis paper examines the impact of increased pre-close transparency on the effectiveness of stock closing call. On January 1, 2003, the Taiwan Stock Exchange increases pre-close transparency by disclosing the best five bid and ask prices and related unexecuted orders before market closing. At the same time, the Taiwan Stock Exchange does not disseminate any information about the limit-order book during the five-minute closing call period. This institutional change presents an opportunity to analyze how an increase in pre-close transparency affects informed trading and price efficiency near market closing. Empirical results show that an increase in pre-close transparency enhances the price efficiency of stock closing call, implying that informed traders will increase their trading during stock closing call following pre-close transparency increases.JEL: G14, G15, G18KEYWORDS: Transparency, Closing call, Price efficiency, Taiwan Stock ExchangeINTRODUCITONThis paper investigates whether an increase in pre-close transparency alters the effectiveness of stock closing call. Previous studies have examined the impact of stock closing call on price efficiency at market closing, and conclude that the introduction of stock closing call could enhance market quality (e.g., Pagano and Schwartz, 2003; Huang and Tsai, 2008). On the other hand, prior studies have examined the effects of transparency on trading behavior of informed traders and the results to date are far from conclusive. One argues that informed traders trade more accurately in a transparent environment since they could tap the liquidity offered by the limit-order book more efficiently (e.g., Madhavan et al., 2005). The other suggests that informed traders prefer markets with less transparency to avoid revealing their private information (e.g., Chowdhry and Nanda, 1991; Comerton-Forde and Rydge, 2006). While there is no consensus in the literature on the influence of transparency on trading behavior of informed traders, this paper provides additional evidence regarding this issue by examining the impact of pre-close transparency on the efficacy of stock closing call.Starting from January 1, 2003, the Taiwan Stock Exchange (TWSE) enhances transparency by disclosing the best five bid and ask prices and related unexecuted orders in the trading period between 9:00 and 13:25. At the same time, the TWSE disseminates no information regarding the limit-order book during the five-minute closing call period surrounding this institutional change. Thus, this unique design provides an opportunity to examine how an increase in pre-close transparency affects informed trading near market closing and then price efficiency of stock closing call.The empirical results indicate that the quotation information, including bid-ask spreads and market depth, do not change significantly near market closing following pre-close transparency increases. However, this change in pre-close transparency results in larger trading volume, and then induces higher adjusted R-square of market model and less absolute return autocorrelation at market closing. The findings provide evidence that the increase in pre-close transparency could enhance the price efficiency of stock closing call. Thus, this paper conclude that, after pre-close transparency increases, informed traders will increase their trading during stock closing call when disclosing no limit-order book information at that time. The findings support Chowdhry and Nanda (1991) that informed traders prefer to trade in an opaque environment.The remainder of this study is organized as follows. Section 2 provides a brief literature review. Section 3 develops the research hypotheses. Section 4 describes how the sample is chosen and the methodology used in this paper. Empirical results are presented in section 5. Section 6 concludes the paper.LITERATURE REVIEWPrevious research examines whether an introduction of stock closing call leads to an improvement in market quality. …