Limit Up Limit Down, Exchange Access Fee and High Frequency Trading Around Price Limits

Abstract

This paper analyzes the impact of intraday dynamic price limit rule - Limit Up Limit Down (LULD) on U.S. equity markets and high frequency trading (HFT) behavior around the price limit. Specifically, this paper examines the following five hypotheses: trading interference, volatility spillover, delayed price discovery, magnet effects and the role of HFT around the price limit on maker-taker vs. taker-maker market. We test the former three hypotheses to compare trading activity patterns, volatility levels, and price continuation and reversal activity. For the magnet effect, we test both speed and magnitude when the price is approaching the upper and lower limit prices on maker-taker and the inverted markets and using a subset of sample stocks switching above and below $3 threshold. In addition, we test how HFT trading behavior changes around price limit. We find LULD interferes with trading activity, but curbs short term volatility without delaying the price discovery process. Also, magnet effect exists when trade price is approaching the price limit. In addition, HFT trading activity dropped after the LULD trading halt which was driven by the decrease in liquidity taking on the maker-taker market while no change on the inverted market.

Keywords: Limit Up Limit Down, Dynamic Price Limit, Magnet Effect, Exchange Access Fee, High Frequency Trading

JEL Classification: G12, G14