Heavy tailed distributions in closing auctions

TL;DR

This paper investigates the heavy tails in closing auction return distributions of European stocks, using a stochastic model to relate order placement tails to return tails and empirically verifying the counter-intuitive finding that removing market orders increases tail heaviness.

Contribution

It introduces a model linking limit order placement tails to return tails and empirically demonstrates that limit orders counteract market order imbalances, affecting tail behavior.

Findings

Heavy tails in return distributions are linked to limit order placement.

Removing market orders increases tail heaviness in closing prices.

Limit orders tend to counteract existing order imbalances.

Abstract

We study the tails of closing auction return distributions for a sample of liquid European stocks. We use the stochastic call auction model of Derksen et al. (2020a), to derive a relation between tail exponents of limit order placement distributions and tail exponents of the resulting closing auction return distribution and we verify this relation empirically. Counter-intuitively, large closing price fluctuations are typically not caused by large market orders, instead tails become heavier when market orders are removed. The model explains this by the observation that limit orders are submitted so as to counter existing market order imbalance.