The magnet effect of circuit breakers and its interactions with price limits

Abstract

Using the rare triggers of market-wide circuit breaker in the Chinese stock markets, we study the magnet effect of the trading halts on stock returns and its interaction with the magnet effect of price limits. Theory suggests that the existence of circuit breaker could actually make the price accelerate toward the boundaries when it gets closer to the limits (the magnet effect), but empirical evidence is scanty. In this paper, we provide evidences on the magnet effect of circuit breaker using high-frequency market index returns and individual stock returns. Furthermore, our empirical tests for the individual stock returns suggest that magnet effect of circuit breaker does not only coexist but also interacts with the magnet effect of price ceiling limit. Based on a small group of stocks that hit their price ceilings during the market collapse, the magnet effect of price ceiling is found to accelerate when a trigger of market-wide circuit breaker is more likely. In one of the circuit breaker proximity measures, the magnet effect of price ceiling increased six-fold when the market index approached to 3% from the circuit breaker threshold.