PRICE DISCOVERY IN THE PRE-OPENING PERIOD. THEORY AND EVIDENCE FROM THE MADRID STOCK EXCHANGE

Abstract

Some stock exchanges, such as the Spanish Stock Exchange and Euronext (Paris), allow traders to place orders in a ‘pre-opening’ period. Orders placed in this period are used to determine the opening price, and can be cancelled at any moment and at no cost by the traders. We consider a model in which noise traders can appear in the market before or after the opening, and a strategic informed trader decides her order strategy at the pre-opening and at the opening period. We characterize the equilibrium of such a model, showing that at the pre-opening there is a non-monotonic relation between the aggregate quantity ordered and prices. Thus, the equilibrium at the pre-opening stage is determined in a way which is fundamentally different from the equilibrium in the open market. We proceed to study the implications of the existence of a pre-opening period on information revelation and on the determination of the opening price. We present evidence from the Spanish Stock Exchange that seem to support the theoretical predictions, showing a clear different in behaviour between the market behaviour before and after the opening of the market.