Dynamic Runs and Circuit Breakers: An Experiment

Abstract

Although now widespread in financial markets, circuit breakers remain controversial among researchers and professional investors. We formalize the popular argument that circuit breakers provide a “cooling-off” period for investors during market runs and we test it in the laboratory. Our experiment reproduces a market where investors fear future liquidity shocks but receive news about the true state over time. Notably, we find that when information quality is poor circuit breakers can have perverse effects on trading behavior. However, when information quality is high, circuit breakers can improve welfare by providing agents with time to learn about the true state, when private incentives to wait for more information are insufficient.

Keywords: circuit breakers, market runs, experiment

JEL Classification: G02, G18, G01.