Effects of Price Limits on Informed Trading Strategies and Market Performances

51 Pages Posted: 10 Mar 2008 Last revised: 27 Apr 2008

See all articles by Tai Ma

Tai Ma

National Sun Yat-sen University

Shu-Fan Hsieh

National Kaohsiung University of Science and Technology

Date Written: April 18, 2008

Abstract

This paper investigates the effect of price limits on strategically informed trading and market performances. We show that a price limit will increase the costs of liquidity traders and volatility spillover by its ex ante effects on strategically informed trading. Our study differs from prior research by focusing on informed traders' strategies and information competitiveness. With long-lived information or less information competitiveness, the price limit rule encourages stealthily informed trading, distorts the price dynamics and increases the trading costs of small liquidity traders. Volatility subsequent to a limit-hit is also increased. By using the listed firms in the Taiwan Stock Exchange, we provide empirical evidences that informed traders switch to trade with small orders when they encounter a price limit and volatility spillover exists. Furthermore, this negative effect is more sever for those stocks with less information competitiveness. Our findings suggest that the ex ante effects of price limits on market performances may be contrary to what the stabilizing mechanism is intended to achieve, especially for those firms with less information competitiveness

Keywords: Price limits, Stealthily trading, Information competitiveness

JEL Classification: G14, G28

Suggested Citation

Ma, Tai and Hsieh, Shu-Fan, Effects of Price Limits on Informed Trading Strategies and Market Performances (April 18, 2008). Available at SSRN: https://ssrn.com/abstract=1104543 or http://dx.doi.org/10.2139/ssrn.1104543

Tai Ma

National Sun Yat-sen University ( email )

70 Lien-hai Rd.
Kaohsiung, 80743
Taiwan
886-7-525-2000 ext. 4810 (Phone)
886-7-525-4899 (Fax)

HOME PAGE: http://www.finance.nsysu.edu.tw/teachers/matai/e-index.htm

Shu-Fan Hsieh (Contact Author)

National Kaohsiung University of Science and Technology ( email )

2 Jhuoyue Rd.
Nanzih
Kaohsiung City, Taiwan 811
Taiwan

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