Abstract
We conducted a comprehensive analysis on the sequential introductions of dynamic and static volatility interruptions (VIs) in the Korean stock markets. The Korea Exchange introduced VIs to improve price formation, and to limit risk to investors from brief periods of abnormal volatility for individual stocks. We found that dynamic VI is effective in price stabilization and discovery, while the effect of static VI is limited. The static VI functions similarly to the pre-existing price-limit system; this accounts for its limited incremental benefit.
Highlights
A volatility interruption (VI), a subcategory of volatility safeguards, is a form of trading pause during which order execution is suspended briefly, while order submissions and cancellations are still allowed
The pre-existing price-limit system on the Korean stock markets allows us to separate the effects of price-limit systems and VIs
The sequential introductions of dynamic and static VIs to the Korean stock markets allowed us to separate the effects of these two types of VIs and compare their effectiveness
Summary
A volatility interruption (VI), a subcategory of volatility safeguards, is a form of trading pause during which order execution is suspended briefly, while order submissions and cancellations are still allowed This sophisticated microstructure mechanism has been designed to provide cooling-off periods and effective price discovery during brief periods of abnormal volatility for individual stocks. If the potential execution price exceeds either the dynamic or static threshold range, all transactions for the individual stock are stopped for a predetermined short period of time, e.g., 2 to 5 min, and trading resumes with a call auction that includes a random-end (RE) trading mechanism (Guillaumie et al 2020).. The KRX documents state that the purpose of VIs is to improve price formation, and to limit risk to investors from brief periods of abnormal volatility. A price-limit system to limit price movements for for the day to a specified percentage
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