Price Dynamics with Circuit Breakers
26 Pages Posted: 2 Jul 2019
Date Written: July 1, 2019
We develop a self-consistent model of the dynamics of an asset price in the presence of a circuit breaker (imposed trading halt). The investors' anticipation of the probability of the halt, and of the dynamics of the underlying value during the halt, feedbacks on the price process. This leads to coupled integral and stochastic differential equations. With first-order analytical solutions compared with a full numerical treatment, the theory predicts generally an increased price volatility prior to the trigger point, as has been reported in the empirical literature. The theory also shows the existence of a competition between a repelling "momentum" term associated with the propensity for investors to anchor on trends and an attractive "rational drift" term corresponding to the anticipation of the impact of the stopping period. Thus, the sole existence of a circuit breaker leads either to a beneficial effect of impeding the price drop for a while or, on the contrary, to the negative effect of attracting the price to the circuit breaker level (known as the "magnet effect"). The latter occurs when the fundamental price has larger negative drifts and is relatively close to the circuit breaker level. We successfully calibrate our model on three different circuit breakers: Cboe bitcoin futures, the Shanghai CSI300 index and the S&P500. Finally, we propose first steps toward a more robust design of circuit breakers.
Keywords: circuit breaker, trading halt, magnet effect
JEL Classification: G10, G18, C51, C54
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