Can Price Limits Help When the Price is Falling? Evidence from Transactions Data on the Shanghai Stock Exchange
34 Pages Posted: 6 Feb 2008 Last revised: 26 Aug 2008
Date Written: 2008
We use transactions data to explore the magnet effects of price limit rules on the Shanghai Stock Exchange (SHSE). When limit hits are imminent, stock prices are found to approach the price limits at faster rates, with higher trading intensity and larger price variation, supporting the magnet effect hypothesis of Subrahmanyam (1994). Moreover, when stock prices approach the floor limits, we observe lower than normal market conditions' trading volume and trade size but a wider spread. The panic selling psychology of individual investors for fear of illiquidity and the strategic trading decisions of discretionary traders during periods prior to price limit hits at the floors are conjectured as possible explanations for the observed price behaviors. Post-limit-hit analysis reveals evidence of delayed price discovery at the ceiling limit but price reversal at the floor.
Keywords: Price limit rules, magnet effect, delayed price discovery, transactions data, Shanghai Stock Exchange
JEL Classification: G14, G15, G18
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