Are Price Limits Always Bad?

Journal of Emerging Market Finance, Vol. 4, No. 3, pp. 281-313, 2005

54 Pages Posted: 19 Jul 2004

Abstract

This paper re-examines the extent, if any, of the negative impacts of price limits. We provide fresh evidence supporting, only partially, the criticisms against the efficacy of such price limits: that price limits cause a spillover of volatility, delay the process of price discovery, and interfere with trading activity. A negative impact of price limits when valid for one group of stocks or direction of price move, may not hold for another group of stocks or direction of price move. The paper also presents a realistic estimate of the potential trading profits that may be made by using price limit hits as a signalling mechanism by "big hands" or as a forecasting tool by strategic traders. With the increase in the number of exchanges using electronic anonymous limit order trading mechanisms, and the greater ease with which regulators may interfere with the price and quantity dynamics, the new findings of this paper will continue to be important for academics, practitioners and regulators alike.

Keywords: Price Limits, Overreaction Hypothesis, Price Discovery, Strategic Trading

JEL Classification: G14, G15, G18

Suggested Citation

Nath, Purnendu, Are Price Limits Always Bad?. Journal of Emerging Market Finance, Vol. 4, No. 3, pp. 281-313, 2005, Available at SSRN: https://ssrn.com/abstract=565481

Purnendu Nath (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://phd.london.edu/pnath

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