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Price Continuity Rules and Insider Trading

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  • Dutta, Prajit K.
  • Madhavan, Ananth

Abstract

Restrictions on transaction price changes are a feature of many security markets. This paper analyzes the impact of such price continuity rules on price dynamics and examines possible rationales for their existence. Contrary to popular belief, continuity rules need not reduce price efficiency, although they do result in a redistribution of profits among traders and dealers. Indeed, continuity rules may enhance price efficiency because traders have greater incentives to gather costly information. We provide a new rationale for continuity rules besides the stated objective of stabilizing prices. In particular, we show that continuity requirements act to restrict dealers' expected profits from trading with liquidity traders. The results provide insights into the design of an “optimal†continuity rule.

Suggested Citation

  • Dutta, Prajit K. & Madhavan, Ananth, 1995. "Price Continuity Rules and Insider Trading," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(2), pages 199-221, June.
    • Handle: RePEc:cup:jfinqa:v:30:y:1995:i:02:p:199-221_00
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    Cited by:

    1. Zhiwu Chen & Werner Stanzl & Masahiro Watanabe, 2002. "Price Impact Costs and the Limit of Arbitrage," Yale School of Management Working Papers ysm251, Yale School of Management, revised 08 Jun 2006.
    2. Martin Barner & Francesco Feri & Charles R. Plott, 2005. "On the microstructure of price determination and information aggregation with sequential and asymmetric information arrival in an experimental asset market," Annals of Finance, Springer, vol. 1(1), pages 73-107, January.
    3. Werner Stanzl & Gur Huberman, 2000. "Arbitrage-Free Price-Update and Price-Impact Functions," Yale School of Management Working Papers ysm164, Yale School of Management, revised 01 Jan 2001.
    4. Gur Huberman & Werner Stanzl, 2005. "Optimal Liquidity Trading," Review of Finance, European Finance Association, vol. 9(2), pages 165-200.
    5. Panayides, Marios A., 2007. "Affirmative obligations and market making with inventory," Journal of Financial Economics, Elsevier, vol. 86(2), pages 513-542, November.
    6. Gur Huberman & Werner Stanzl, 2000. "Optimal Liquidity Trading," Yale School of Management Working Papers ysm165, Yale School of Management, revised 01 Aug 2001.
    7. Lajbcygier, Paul & Sojka, Jeremy, 2015. "The viability of alternative indexation when including all costs," International Review of Financial Analysis, Elsevier, vol. 38(C), pages 109-141.
    8. Zhiwu Chen & Werner Stanzl & Masahiro Watanabe, 2002. "Price Impact Costs and the Limit of Arbitrage," Yale School of Management Working Papers ysm251, Yale School of Management, revised 08 Jun 2006.
    9. Madhavan, Ananth & Panchapagesan, Venkatesh, 2000. "Price Discovery in Auction Markets: A Look Inside the Black Box," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 627-658.
    10. Werner Stanzl & Gur Huberman, 2000. "Arbitrage-Free Price-Update and Price-Impact Functions," Yale School of Management Working Papers ysm164, Yale School of Management, revised 01 Jan 2001.
    11. Diamond, Stephen F. & Kuan, Jennifer W., 2018. "Are the stock markets “rigged”? An empirical analysis of regulatory change," International Review of Law and Economics, Elsevier, vol. 55(C), pages 33-40.

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