The Puzzle of Privately-Imposed Price Limits: Are the Limits Imposed by Financial Exchanges Effective

IEB International Journal of Business, January 2011

Posted: 7 Jan 2011  

Bahattin Buyuksahin

Bank of Canada

David Reiffen

U.S. Commodity Futures Trading Commission (CFTC)

Date Written: January 5, 2011

Abstract

Some of the world’s largest futures exchanges impose daily limits on the price movements of individual contracts. Using data from three of the most active US commodity futures contracts, we show that these price restrictions are largely ineffective because traders are able to take similar positions using other contracts. When price limits become binding on the futures market, the associated (but unrestricted) options market becomes the price discovery market: much of the trading that would have occurred on the futures market migrates to the options market, and options prices accurately predict the (unconstrained) futures price the next day. We also show that the presence of options mitigates the effect of price limits on information revelation by documenting that futures markets reflect more accurate information on days following limit hits when the associated options were trading on the previous day. Overall, our evidence suggests that price limits in US futures markets have little effect on prices when options markets exist.

Keywords: price limits, regulatory evasion, put-call parity, satellite market, price discovery

JEL Classification: G10, G13

Suggested Citation

Buyuksahin, Bahattin and Reiffen, David, The Puzzle of Privately-Imposed Price Limits: Are the Limits Imposed by Financial Exchanges Effective (January 5, 2011). IEB International Journal of Business, January 2011. Available at SSRN: https://ssrn.com/abstract=1735670

Bahattin Buyuksahin

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

David Reiffen (Contact Author)

U.S. Commodity Futures Trading Commission (CFTC) ( email )

Three Lafayette Centre
1155 21st Street, NW
Washington, DC 20581
United States

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