Toward a Flexible Price Limit System
Posted: 25 Mar 2008
Date Written: August 1, 2007
This paper proposes an improvement to the existing price limit systems. Using price limit data from Tokyo Stock Exchange, this study shows that price limits are costly when they obstruct rational price movements. Observable events, such as volatility spillovers and consecutive price limit hits, associated to improper price limit imposition can be predicted using proxies of informed and uninformed trading, changes in order imbalance, number of trades hitting price limit, fraction of the trading day affected by limit hit and security characteristics such as size, growth and idiosyncratic risk. We propose a flexible price limit system based on the predicted likelihood of improper price limit imposition. We suggest that if exchange-officials decide on relaxing or continue imposing price limits for a trading day based on predicted probability of volatility spillover and consecutive hit then price limit rules could become effective.
Keywords: Price Limits, Volatility Spillover, Probit Model
JEL Classification: G10, G18, G19
Suggested Citation: Suggested Citation