Annals of Operations Research

, Volume 260, Issue 1–2, pp 129–157 | Cite as

Do price limits help control stock price volatility?

S.I.: Advances of OR in Commodities and Financial Modelling

Abstract

On the negative side, price limits are criticized for increasing stock price volatility and hindering the price discovery process. On the positive side, price limits are argued to give panicky investors additional time to reassess their judgments and thus provide an opportunity for correcting the element of overreaction in pricing stocks. This study analyzes the effectiveness of price limits in Borsa Istanbul by utilizing a propensity-matched control sample in addition to the traditional benchmarks used in the literature. Similar to recent research, we find strong evidence that price limits lead to increased and persistent price volatility and decreased liquidity. We also provide evidence that price limits interfere with the price discovery process. Results show that smaller stocks with larger volatility and higher trading volume are more likely to experience limit hits. Furthermore, the difference in the findings from the matched control sample and the traditional benchmarks points out the importance of accounting for firm- and market-related characteristics when analyzing the effect of price limits.

Keywords

Price limit Volatility Price discovery 

References

  1. Ackert, L. F., Huang, Y., & Jiang, L. (2015). Investor sentiment and price limit rules. Journal of Behavioral and Experimental Finance, 5, 15–26.CrossRefGoogle Scholar
  2. Al-Khouri, R. S., & Ajlouni, M. M. (2007). Narrow price limit and stock price volatility in emerging markets: empirical evidence from Amman stock exchange. The International Journal of Business and Finance Research, 1, 104–120.Google Scholar
  3. Arak, M., & Cook, R. E. (1997). Do daily price limits act as magnets? The case of Treasury bond futures. Journal of Financial Services Research, 12, 5–20.CrossRefGoogle Scholar
  4. Belcher, L., Ma, C. K., & Mallett, J. E. (2003). The information content of price limit moves. International Journal of Business, 8, 1083–4346.Google Scholar
  5. Berkman, H., & Lee, J. B. (2002). The effectiveness of price limits in an emerging market: Evidence from the Korean Stock Exchange. Pacific-Basin Finance Journal, 10, 517–530.CrossRefGoogle Scholar
  6. Berkman, H., & Steenbeek, O. W. (1998). The influence of daily price limits on trading in Nikkei futures. The Journal of Futures Markets, 18, 265–279.CrossRefGoogle Scholar
  7. Bildik, R., & Elekdag, S. (2004). Effects of price limits on volatility: Evidence from the Istanbul Stock Exchange. Emerging Markets Finance and Trade, 40, 5–34.Google Scholar
  8. Bildik, R., & Gulay, G. (2006). Are price limits effective? Evidence from the Istanbul Stock Exchange. Journal of Financial Research, 29, 383–403.CrossRefGoogle Scholar
  9. Blume, M. E., MacKinlay, A. C., & Terker, B. (1989). Order imbalances and stock price movements on October 19 and 20. 1987. Journal of Finance, 44, 827–848.CrossRefGoogle Scholar
  10. Chan, S. H., Kim, K. A., & Rhee, S. G. (2005). Price limit performance: Evidence from transactions data and the limit order book. Journal of Empirical Finance, 12, 269–290.CrossRefGoogle Scholar
  11. Chang, C. H., & Hsieh, S. L. (2008). Is the daily price limit of the Taiwan stock exchange effective? Fundamentals of listed stocks and investors’ perception of fair price. Asia-Pacific Journal of Financial Studies, 37, 675–726.Google Scholar
  12. Dabbou, H. (2013). Evaluating the widening of price limits: Evidence from Tunisian stock exchange. Journal of Business Studies Quarterly, 4, 140–159.Google Scholar
  13. Dabbou, H., & Silem, A. (2014). Price limit and financial contagion: Protection or illusion? The Tunisian Stock Exchange case. International Journal of Economics and Financial Issues, 4, 54–70.Google Scholar
  14. Deb, S. S., Kalev, P. S., & Marisetty, V. B. (2010). Are price limits really bad for equity markets? Journal of Banking and Finance, 34, 2462–2471.CrossRefGoogle Scholar
  15. Deb, S. S., Kalev, P. S., & Marisetty, V. B. (2013). Flexible price limits: The case of Tokyo stock exchange. International Financial Markets, Institutions and Money, 24, 66–84.CrossRefGoogle Scholar
  16. Diacogiannisa, G. P., Patsalis, N., Tsangarakis, N. V., & Tsiritakisa, E. D. (2005). Price limits and overreaction in the Athens stock exchange. Applied Financial Economics, 158, 53–61.CrossRefGoogle Scholar
  17. Fama, E. (1989). Perspectives on October 1987, or What Did We Learn from the Crash?”. In R. W. Kamphuis Jr., R. C. Kormendi, & J. W. H. Watson (Eds.), Black Monday and the future of the financial markets. Irwin: Homewood.Google Scholar
  18. Farag, H. (2013). Price limit bands, asymmetric volatility and stock market anomalies: Evidence from emerging markets. Global Finance Journal, 24, 85–97.CrossRefGoogle Scholar
  19. Farag, H. (2015). The influence of price limits on overreaction in emerging markets: Evidence from the Egyptian stock market. The Quarterly Review of Economics and Finance, 58, 190–199.CrossRefGoogle Scholar
  20. Farag, H., & Cressy, R. (2011). Do regulatory policies affect the flow of information in emerging markets? Research in International Business and Finance, 25, 238–254.CrossRefGoogle Scholar
  21. French, K. R., & Roll, R. (1986). Stock return variances: The arrival of information and the reaction of traders. Journal of Financial Economics, 17, 5–26.CrossRefGoogle Scholar
  22. Friedmann, R., & Sanddorf-Köhle, W. G. (2007). A conditional distribution model for limited stock index returns. Journal of Economic Dynamics & Control, 31, 721–741.CrossRefGoogle Scholar
  23. Greenwald, B. C., & Stein, J. C. (1991). Transactional risk, market crashes, and the role of circuit breakers. Journal of Business, 64, 443–462.CrossRefGoogle Scholar
  24. Grossman, S. J. (1988). Program trading and market volatility: A report on interday relationships. Financial Analysts Journal, 44, 18–28.CrossRefGoogle Scholar
  25. Gujarati, D. N. (2003). Basic econometrics. New York: McGraw-Hill Education.Google Scholar
  26. Guo, J. H., Chang, L. F., & Hung, M. W. (2015). Limit hits and informationally related stocks. European Financial Management Association Meeting, 1–58.Google Scholar
  27. Harel, A., Harpaz, G., & Francis, J. C. (2007). Pricing securities with exchange-imposed price limits via risk neutral valuation. International Journal of Theoretical and Applied Finance, 10, 399–406.CrossRefGoogle Scholar
  28. Harris, L., & Gurel, E. (1986). Price and volume effects associated with changes in the S&P 500 list: New evidence for the existence of price pressures. The Journal of Finance, 41, 815–829.CrossRefGoogle Scholar
  29. Hassanein, M., & Tooma, E. A. (2007). The effect of price limits on unconditional volatility: The case of CASE. Frontiers in Finance and Economics, 4, 125–143.Google Scholar
  30. Holder, M. E., Ma, C. K., & Mallett, J. E. (2002). Futures price limit moves as options. The Journal of Futures Markets, 22, 901–913.CrossRefGoogle Scholar
  31. Hsieh, P. H., Kim, Y. H., & Yang, J. J. (2009). The magnet effect of price limits: A logit approach. Journal of Empirical Finance, 16, 830–837.CrossRefGoogle Scholar
  32. Kao, G. W., & Ma, C. K. (1992). Memories, heteroscedasticity, and price limit in currency futures markets. The Journal of Futures Markets, 12, 679–692.CrossRefGoogle Scholar
  33. Karpoff, J. M. (1987). The relation between price changes and trading volume: A survey. Journal of Financial and Quantitative Analysis, 22, 109–126.CrossRefGoogle Scholar
  34. Khodavandloo, M., & Zakaria, Z. (2013). The effects of price limits in an emerging market: Evidence from the Bursa Malaysia. International Academic Workshop on Social Science, 13, 114–117.Google Scholar
  35. Kim, K. A., & Limpaphayom, P. (2000). Characteristics of stocks that frequently hit price limits: Empirical evidence from Taiwan and Thailand. Journal of Financial Markets, 3, 315–332.CrossRefGoogle Scholar
  36. Kim, K. A., Liu, H., & Yang, J. J. (2013). Reconsidering price limit effectiveness. The Journal of Financial Research, 36, 493–517.CrossRefGoogle Scholar
  37. Kim, K. A., & Park, J. (2010). Why do price limits exist in stock markets? A manipulation-based explanation. European Financial Management, 16, 296–318.CrossRefGoogle Scholar
  38. Kim, K. A., & Rhee, S. G. (1997). Price limit performance: Evidence from the Tokyo stock exchange. The Journal of Finance, 52, 885–901.CrossRefGoogle Scholar
  39. Kim, Y. H., Yagüe, J., & Yang, J. J. (2008). Relative performance of trading halts and price limits: Evidence from the Spanish Stock Exchange. International Review of Economics and Finance, 17, 197–215.CrossRefGoogle Scholar
  40. Kuhn, B. A., Kurserk, G. J., & Locke, P. (1991). Do circuit breakers moderate volatility? Evidence from October 1989. The Review of Futures Markets, 10, 136–175.Google Scholar
  41. Kyle, A. S. (1988). Trading halts and price limits. The Review of Futures Markets, 7, 426–434.Google Scholar
  42. Lee, J. H., & Chou, R. K. (2004). The intraday stock return characteristics surrounding price limit hits. Journal of Multinational Financial Management, 14, 485–501.CrossRefGoogle Scholar
  43. Lee, C. M. C., Ready, M. J., & Seguin, P. J. (1994). Volume, volatility, and New York stock exchange trading halts. Journal of Finance, 48, 183–214.CrossRefGoogle Scholar
  44. Li, H., Zheng, D., & Chen, J. (2014). Effectiveness, cause and impact of price limit: Evidence from China’s cross-listed stocks. International Financial Markets, Institutions and Money, 29, 217–241.CrossRefGoogle Scholar
  45. Lia, M. H., Lin, C. C., & Wang, Y. (2011). The effects of removing price limits: Evidence from Taiwan IPO stocks. Emerging Markets Trade & Finance, 47, 40–52.CrossRefGoogle Scholar
  46. Lin, A. Y., & Swanson, P. E. (2010). Contrarian strategies and investor overreaction under price limits. Journal of Economics and Finance, 34, 430–454.CrossRefGoogle Scholar
  47. Ma, C. K., Rao, R. P., & Sears, R. S. (1989). Volatility, price resolution, and the effectiveness of price limits. Journal of Financial Services Research, 3, 165–199.CrossRefGoogle Scholar
  48. Maghyereh, A. I., Al Zoubi, H. A., & Nobanee, H. (2007). price limit and volatility in Taiwan stock exchange: Some additional evidence from the extreme value approach. Review of Pacific Basin Financial Markets and Policies, 10, 51–61.CrossRefGoogle Scholar
  49. Martens, M., & Steenbeek, O. W. (2001). Intraday trading halts in the Nikkei futures market. Pacific-Basin Finance Journal, 9, 535–561.CrossRefGoogle Scholar
  50. Michalon, K. (2013). How do price limits influence French market microstructure? A high frequency data analysis in terms of return, volatility and volume. Midwest Finance Association Annual Meeting Paper, pp 1–54.Google Scholar
  51. Naughton, T., & Veeraraghavan, M. (2004). Are price limits priced? Evidence from the Taiwan stock exchange. Journal of Emerging Markets Finance, 3, 249–267.CrossRefGoogle Scholar
  52. Pastor, L., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685.CrossRefGoogle Scholar
  53. Schwert, G. W. (1989). Why does stock market volatility change over time? The Journal of Finance, 44, 1115–1153.CrossRefGoogle Scholar
  54. Wan, Y. L., Xie, W. J., Gu, G. F., Jiang, Z. Q., Chen, W., Xiong, X., et al. (2015). Statistical properties and pre-hit dynamics of price limit hits in the Chinese stock markets. PLoS ONE, 10, 1–20.Google Scholar
  55. Wang, D., Chong, T. T. L., & Chan, W. H. (2014). Price limits and stock market volatility in China. Munich PersonalRePEc Archive Working Paper, No. 54146, 1–29.Google Scholar

Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  1. 1.Department of Business Administration and Institute of Applied MathematicsMiddle East Technical UniversityAnkaraTurkey

Personalised recommendations