Preopening price indications and market quality: Evidence from NYSE Rule 48

• Published date: 01 June 2022
• Author: Kee H. Chung,Chairat Chuwonganant,Youngsoo Kim
• Date: 01 June 2022
• DOI: http://doi.org/10.1111/jfir.12272

Received: 17 December 2020

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Accepted: 14 November 2021

DOI: 10.1111/jfir.12272

ORIGINAL ARTICLE

Preopening price indications and market quality:

Evidence from NYSE Rule 48

Kee H. Chung

1,2

|Chairat Chuwonganant

3

|Youngsoo Kim

4

1

Department of Finance, School of

Management, State University ofNew York

(SUNY) at Buffalo, Buffalo, New York,

United States

2

Department of Finance, School of Business,

Sungkyunkwan University, Seoul, Republic

of Korea

3

Department of Finance, College of Business

Administration, Kansas State University,

Manhattan, Kansas, United States

4

Faculty of Business Administration,

University of Regina, Regina, Canada

Correspondence

Kee H. Chung, Department of Finance, School

of Management, State University of New

York (SUNY) at Buffalo, Buffalo, NY 14260,

USA.

Email: keechung@buffalo.edu

Abstract

In this article, we explore the role of preopening price

signals in price discovery and liquidity. NYSE Rule 48

suspends the responsibility of designated market makers

for disseminating preopening price indications in the event

of extreme marketwide volatility. Rule 48 speeds up the

opening of stocks at the expense of lower liquidity. The

absence of preopening price indications results in reduced

liquidity during the first 30min of the trading day. We

interpret this finding as evidence that liquidity suppliers

are less willing to provide liquidity in the absence of a

reference point or benchmark regarding stock value.

JEL CLASSIFICATION

G01, G10, G14, G18

1|INTRODUCTION

Two important functions of financial markets are to reduce trading costs by providing liquidity and to expedite price

discovery. Low trading costs facilitate asset exchanges, and efficient price discovery improves capital allocations.

On the New York StockExchange(NYSE), designatedmarket makers(DMMs) playan essential roleasliquidity

providers of last resort. In general, financial markets expedite price discovery through rules and regulations that

facilitate the aggregation of information into asset prices. For instance, pretrade and posttrade transparency,

including preopening protocols on the NYSE, are intended to expedite price discovery. In this study, we explore the

effect of the procedure of opening stocks (i.e., Rule 48) on liquidity and pricediscovery.

Boehmer et al. (2005), Chung and Chuwonganant (2009), and Foley and Putniņš (2016) analyze the effect of

pretrade transparency (i.e., OpenBook on the NYSE, SuperMontage on Nasdaq, and dark pools) on liquidity and

price discovery during regular trading hours. Prior studies have also examined the role of DMMs in the price

discovery process during regular trading hours (see, e.g., Anand & Venkataraman, 2016; Bessembinder et al., 2015;

J Financ Res. 2022;45:205–228. wileyonlinelibrary.com/journal/JFIR

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© 2022 The Southern Finance Association and the Southwestern Finance Association.

Clark‐Joseph et al., 2017; Menkveld & Wang, 2013; Panayides, 2007; Venkataraman & Waisburd, 2007). Market

forces that work well during regular trading hours are likely to be constricted during the market opening, especially

at times of high volatility. Hence, the optimal design of protocols for opening markets may need to solve a different

price discovery/liquidity problem than regular trading hours. Our article extends the literature by analyzing the role

of preopening price signals provided by DMMs on the NYSE. In particular, we illuminate the role of preopening

price signals by examining the effect of Rule 48 on stock opening delay and liquidity.

Rule 48 is perhaps one of the most controversial and contested rules because of its mixed effects on market

quality. For instance, it has been widely covered by major media outlets such as the Wall Street Journal (e.g., Phillips,

2010), Financial Times (e.g., Rennison & Bullock), and NBC News (e.g., Lenzo, 2015). Rule 48 was originally meant to

ensure that stock openings are not unduly delayed in times of high market volatility by suspending the responsibility

of DMMs for disseminating price indications before the bell (i.e., preopening price indications) on the NYSE.

Although anecdotal evidence and casual observations suggest that Rule 48 affects market quality, there is no hard

empirical evidence. To the best of our knowledge, ours is the first study to provide such evidence.

Rule 48 was approved by the US Securities and Exchange Commission (SEC) on December 6, 2007, first

invoked on December 12, 2007, and last used on September 1, 2015. Rule 48 was invoked 78 times, and more

frequently (37 times) in the first 12 months. Rule 48 was mostly unknown to the general public and media until

August 24, 2015. On that day, the equity market opened 7% down, many NYSE stocks experienced opening delays,

and prices of exchange‐traded funds (ETFs) were dislocated from prices of underlying stocks. The tumult in markets

on August 24, 2015 brought Rule 48 to the intense attention and criticism of the media and investment community

(see., e.g., Trugman, 2015; Wells, 2015). After the episode of August 24, 2015, the NYSE proposed a new stock

opening process on March 31, 2016, outlined in Rule 15, Rule 123D, and Rule 48 in its filing with the SEC.

1

Rule 48, along with Rule 15 and Rule 123D, describes the procedure of opening stocks on the NYSE. DMMs are

responsible for opening a stock as close as possible to 9:30 a.m. DMMs can open a stock on a quote or a trade.

Openings, which can be done electronically or manually, should be timely, fair, and orderly. Under Rule 15 and

Rule 123D, DMMs are required to publish preopening price indications if a stock is expected to open at a price

significantly different from the previous closing price. The conditions under which DMMs publish preopening price

indications differ slightly between Rule 15 and Rule 123D.

2

In addition, DMMs need to obtain an NYSE official's

approval for preopening indications under Rule 123D. They also need to display the Rule 123D indications for some

time before they can open the stock.

3

The dissemination of preopening price indications is a manual process. Moreover, the requirement for

preopening price indications is designed to deal with a situation where only a handful of stocks are expected to

open at a disparity from the previous closing price. In the event of extreme marketwide volatility, however, DMMs

would need to disseminate a large number of preopening price indications, and this time‐consuming procedure

would cause excessive delays in opening the stocks. In such a case, a qualified exchange officer may invoke Rule

48.

4

Rule 48 temporarily suspends (1) the need for prior approval from NYSE floor official or floor operations to

open or reopen a stock at the exchange (Rule 123D) and (2) the requirement to make preopening indications in a

stock (Rule 15 and Rule 123D).

At first glance, Rule 48 appears to be an innocuous and relatively straightforward way to speed up the opening

process at some expense of price discovery because of the absence of preopening price signals. However, there are

several subtle points toconsider.First,the NYSE transmits information onpreopenorder imbalance every 15 s from

1

Updated Rule 15 and Rule 123D incorporate articles previously in Rule 48, making Rule 48 redundant. The SEC approved the proposed rule change on

July 5, 2016. Eventually, Rule 48 was removed on September 12, 2016, as revised Rule 15 and Rule 123D became effective.

2

In general, price ranges specified in Rule 15 are tighter than those in Rule 123D.

3

Under Rule 123D, a DMM needs to wait for 3min before the DMM can open a stock, after publishing the first price indication. During this waiting period,

the DMM works to raise the awareness of a possible price dislocation and to attract available liquidity.

4

A qualified exchange officer may be the chief executive officer (CEO) of the Intercontinental Exchange (ICE) or his or her designee, or the CEO of NYSE

Regulation Inc. or his or her designee.

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