Reiffen, David and Buyuksahin, Bahattin (2010): The puzzle of privately-imposed price limits: are the limits imposed by financial exchanges effective? Published in: Aestimatio No. 1 (December 2010): pp. 1-34.
Download (2MB) | Preview
Some of the world’s largest futures exchanges impose daily limits on the price movements of individual contracts. Using data from three of the most active US commodity futures contracts, we show that these price restrictions are largely ineffective because traders are able to take similar positions using other contracts. When price limits become binding on the futures market, the associated (but unrestricted) options market becomes the price discovery market: much of the trading that would have occurred on the futures market migrates to the options market, and options prices accurately predict the (unconstrained) futures price the next day. We also show that the presence of options mitigates the effect of price limits on information revelation by documenting that futures markets reflect more accurate information on days following limit hits when the associated options were trading on the previous day. Overall, our evidence suggests that price limits in US futures markets have little effect on prices when options markets exist.
|Item Type:||MPRA Paper|
|Original Title:||The puzzle of privately-imposed price limits: are the limits imposed by financial exchanges effective?|
|English Title:||the Puzzle of Privately-imposed Price limits: Are the Limits Imposed by Financial Exchanges Effective?|
|Keywords:||Price limits, Regulatory evasion, Put-call parity, Satellite market, Price discovery|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G10 - General
G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing
|Depositing User:||IEB Research Department|
|Date Deposited:||14. Jan 2012 02:43|
|Last Modified:||21. Sep 2015 03:56|
Barone-Adesi, G. and Whaley, R. (1987). Efficient Analytic Approximation of American Option Values, Journal of Finance, 42, pp. 301-20.
Berkman, H. and Steenbeek, O.W. (1998). Daily Price Limits and Trading in Nikkei Futures, Journal of Futures Markets, 18, pp. 265-279.
Brennan, M. (1986). A Theory of Price Limits in Futures Markets, Journal of Financial Economics, 16, pp. 213-33.
Chen, H. (1998). Price Limits, Overreaction, and Price Resolution in Futures Markets, Journal of Futures Markets, 18, pp. 243-63.
Christie W., Corwin, S. and Harris, J. (2002). Nasdaq Trading Halts: The Impact of Market Mechansims on Price, Trading Activity, and Execution Costs, Journal of Finance, 57, pp. 1443-1478.
Chou, P-H., Lin, M-C. and Yu, M-T. (2005). Risk Aversion and Price Limits in Futures Markets, Finance Research Letters, 2, pp. 173-184.
Chowdry, B and V. Nanda (1998). Leverage and Market Stability: The Role of Margin Rules and Default Risk, Journal of Business, 71, pp. 179-210.
Egelkraut, T., García, P. and Sherrick, B. (2007). Options-Based Forecasts of Futures Prices in the Presence of Limits Moves, Applied Economics, 39, pp. 145-152.
Evans, J. and Mahoney, J. (1996). The Effect of Daily Price Limits on Cotton Futures and Options Trading. WP. New York: Federal Reserve Bank of New York.
Frech, H.E. III and Lee, W. C. (1987). The Welfare Cost of Rationing by Queuing across Markets: Theory and Estimates from the U.S. Gasoline Crises, Quarterly Journal of Economics, 102, pp. 97-108.
Glaeser, E. and Luttmer, E. F. (2003). The Misallocation of Housing under Rent Control, American Economic Review, 93, pp. 1027-1046.
Glosten, L. (1987). Components of the Bid-Ask Spread, and the Statistical Properties of Transaction Prices, The Journal of Finance, 42, pp. 1293-1307.
Grossman, S. (1988). An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies, Journal of Business, 61, pp. 275-298. Hall, A., Kofman. P. and Manaster, S. (2006). Migration of Price Discovery in Semiregulated Derivatives Markets, The Journal of Futures Markets, 26, pp. 209-241. Kim, K. and Rhee, S. (1997). Price Limit Performance: Evidence from the Tokyo Stock Exchange, The Journal of Finance, 52, pp. 885-899.
Kim, Y. and Yang, J. (2004). What Makes Circuit Breakers Attractive to Financial Markets: A Survey Financial Markets, Institutions and Instruments, 13, pp. 109-146.
Kolb, R.W. and Overdahl, J.A. (2006). Understanding Futures Markets, Blackwell Publishing, New York.
Kodres, L. and O’Brien, D. (1994). The Existence of Pareto-Superior Price Limits, American Economic Review, 84, pp. 919-933.
Kuserk, G. and Locke, P. (1996). Market Making With Price Limits, Journal of Futures Markets, 16, pp. 677-696.
Lo, A. and Wang, J. (2002). Trading Volume: Definitions, Data Analysis and Implications of Portfolio Theory, Review of Financial Studies, 13, pp. 257-300.
Ma, C., Rao, R. and Sears, R. (1989). Volatility, Price Resolution, and the Effectiveness of Price Limits, Journal of Financial Services Research, 3, pp. 165-199.
Martell, T. and Wolf, A. (1987). Determinants of Trading Volume in Futures Markets, Journal of Futures Markets, 7, pp. 233-244.
Martin, P. and Overdahl, J. (1994). The Exercise of Equity Options: Theory and Empirical Evidence, Journal of Derivatives, 2, pp. 38-51.
Mayhew, S. (2000). The Impact of Derivatives on Cash Markets: What Have We Learned?, Working paper, U.S. Securities and Exchange Commission.
Newey, W and West, K. (1987). A Simple Positive Semi-Definite, Heteroskeasticity and Autocorrelation Consistent Covariance Matrix, Econometrica, 51, pp. 76-89.
Park, C. (2000). Examining Futures Price Changes and Volatility on Trading Days After a Limit-Lock Day, The Journal of Futures Markets, 20, pp. 445-466.
Phylaktis, K., Kavusannos, M. and Manalis, G. (1999). Price Limit and Stock Market Volatility in the Athens Stock Exchange, European Financial Management, 5, pp. 69-84.
Ramaswamy, K.and Sundaresan, S.M. (1985). The Valuation of Options on Futures Contracts. Journal of Finance, 40, pp. 33-59.
Shanker, L. and Balakrishnan, N. (2005). Optimal Clearing Margin, Capital and Price Limits for Futures Clearinghouses, Journal of Banking and Finance, 29, pp. 1611-1630.
Subrahmanyam, A. (1994). Circuit Breakers and Market Volatility: A Theoretical Perspective, Journal of Finance, 49, pp. 237-254.
Veld-Merkoulova, Y. (2003). Price Limits in Futures Markets: Effects on the Price Discovery Process and Volatility, International Review of Financial Analysis, 12, pp. 311-328.