Are Price Limits on Futures Markets that Cool? Evidence from the Brazilian Mercantile and Futures Exchange
Queen Mary University of London - Economics Department
Marco Aurélio Dos Santos Rocha
affiliation not provided to SSRN
Journal of Financial Econometrics, Vol. 5, Issue 2, pp. 219-242, 2007
This article investigates the impact of price limits on the Brazilian futures markets using high frequency data. The aim is to identify whether there is an ex ante cool-off or magnet effect. For that purpose, we examine a tick-by-tick data set that includes all contracts on the São Paulo stock index futures traded on the Brazilian Mercantile and Futures Exchange (BM&F) from January 1997 to December 1999. The results indicate that, altogether, there is a dominant cool-off effect in play and that the latter is much stronger for the floor rather than ceiling price. This explains why we observe more hits to the ceiling rather than to the floor in our sample despite the fact it covers one of the most turbulent periods for emerging markets. We then build a trading strategy that accounts for the cool-off effect in the conditional mean so as to demonstrate that the latter has not only statistical but also economic significance. The Sharpe ratio is indeed way superior to the buy-and-hold benchmarks we consider.
Keywords: cool-off effect, futures markets, magnet effect, price limits, transactions data
Date posted: June 16, 2008