The stabilizing effects of price limits: New evidence from jump contributed price variations

Abstract

We re-examine the effects of price limits on market stabilization, arguing that the prior studies have tended to overlook the endogeneity arising from the market mechanism restrictions imposed by regulators to prevent abnormal market movements when volatility is particularly high. In order to avoid the neglected reverse causality of identifying the policy effects of price limits from the literature, we probe the problem empirically by investigating the realized jump activities by separating the ‘jump contributed price variations’ from the continuously evolved volatility. Our results reveal that whilst the pattern of realized variance across various price limits provides no clear picture of the problem, the jump components under tighter price limit intervals are found to be significantly lower. Contrary to the prior works, in which it is invariably argued that price limits have no stabilizing effect on volatility in the presence of any simultaneous bias, our findings are largely consistent with the claims by regulators that restraining price limits can effectively moderate extreme price movements. A conservative interpretation of our findings is that although adjusting the price limit may not be able to totally reduce price variations, it can at least mitigate the undesired radical price movements (jumps) that are often found to occur.