Effects of Price Limits on Volatility: Evidence from the Istanbul Stock Exchange

28 Pages Posted: 16 Mar 2002

See all articles by Recep Bildik

Recep Bildik

Borsa Istanbul (Istanbul Stock Exchange)

Selim Elekdag

Johns Hopkins University - Department of Economics

Date Written: February 28, 2002

Abstract

There has been much discussion among the regulators, investors and academics in policy circles to control the increasing volatility by using the price limits on financial markets. In spite of the strong existence of price limits worldwide, there is no much information regarding the effects of price limits on volatility and price discovery. Most of the previous studies find no evidence for the price limits that reduce the volatility.

This study examines the effects of price limits on volatility in stock returns through testing the overreaction and information hypotheses by using the same methodology in Phylaktis et al. (1999) for Athens Stock Exchange in one of the leading emerging markets - Istanbul Stock Exchange (ISE) in the period between years 1990 and 2001 for a larger sample. More specifically, we investigate the effects of increase in price limits on volatility in ISE in the period following the structural change in July 14, 1994 since daily cumulative price limit is doubled as a result of transition from one to two sessions in a trading day by using the econometric techniques such as serial correlation and GARCH models.

Our results do not support the information hypothesis in contrast to findings of Phylaktis et al. (1999). Serial correlation analysis gives us no strong evidence to reject or confirm the information hypothesis and inconclusive. Therefore, this inconclusive result motivates us to further analysis in future. GARCH estimation on daily and monthly stock returns controlling for structural breaks, financial and economic crises, trading activity and macroeconomic factors point out in a direction that volatility on stock returns has reduced despite the increase in daily price limits in the period following the structural change in ISE on 14 July, 1994. The majority of stock exhibit a negative and significant sign for the coefficient on the dummy variable. The results are robust to data frequency, leverage effect, financial crises and macroeconomic indicators.

In other words, with double sessions and despite broader implicit daily price limit ranges, volatility seems to decline. Findings imply that transition from one to two sessions in a trading day with lunch-break makes positive impact in reducing the volatility in a environment where the price limit is almost doubled. It seems that the two hour lunch-break between the daily sessions has the effect of a circuit breaker, thus facilitating the dissemination of information and preventing severe overreaction to news events which is consistent to overreaction hypothesis.

Finally, we find that volatility has decreased after the increase in price limits both for cross-section of stocks and overall index as well in ISE and thus price limits have no impact on volatility in stock market by the positive contribution of trading halt in the middle of the trading day.

Keywords: Price limits, volatility, emerging markets, ARCH-GARCH modelling

JEL Classification: G10, G14

Suggested Citation

Bildik, Recep and Elekdag, Selim, Effects of Price Limits on Volatility: Evidence from the Istanbul Stock Exchange (February 28, 2002). Available at SSRN: https://ssrn.com/abstract=302363 or http://dx.doi.org/10.2139/ssrn.302363

Recep Bildik (Contact Author)

Borsa Istanbul (Istanbul Stock Exchange) ( email )

Borsa Istanbul
Resitpasa, Emirgan
Istanbul, 34467
Turkey
90-212-298 21 93 (Phone)
90-212-298 25 00 (Fax)

Selim Elekdag

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States
410-516-7601 (Phone)

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