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The cooling-off effect of price limits in the Chinese stock markets

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  • Wan, Yu-Lei
  • Wang, Gang-Jin
  • Jiang, Zhi-Qiang
  • Xie, Wen-Jie
  • Zhou, Wei-Xing

Abstract

The price limit trading rule is one of the most widely adopted measures on restricting stock price volatilities in some stock markets. It is expected to stabilize the stock markets and enhance the efficiency of the market allocations. The existence of the cooling-off effect or the magnet effect, induced by the price limit trading rule, is the main controversy of this policy. In this paper, we investigate the cooling-off effect (opposite to the magnet effect) from two aspects. Firstly, from the viewpoint of dynamics, we study the existence of the cooling-off effect by following the dynamical evolution of some financial variables over a period of time before the stock price hits its limit. Secondly, from the probability perspective, we investigate, with the logit model, the existence of the cooling-off effect through analyzing the high-frequency data of all A-share common stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange from 2000 to 2011 and inspecting the trading period from the opening phase prior to the moment that the stock price hits its limits. A comparison is made of the properties between up-limit hits and down-limit hits, and the possible difference will also be compared between bullish and bearish market state by dividing the whole period into three alternating bullish periods and three bearish periods. We find that the cooling-off effect emerges for both up-limit hits and down-limit hits, and the cooling-off effect of the down-limit hits is stronger than that of the up-limit hits. The difference of the cooling-off effect between bullish period and bearish period is quite modest. Moreover, we examine the sub-optimal orders effect, and infer that the professional individual investors and institutional investors play a positive role in the cooling-off effects. All these findings indicate that the price limit trading rule exerts a positive effect on maintaining the stability of the Chinese stock markets.

Suggested Citation

  • Wan, Yu-Lei & Wang, Gang-Jin & Jiang, Zhi-Qiang & Xie, Wen-Jie & Zhou, Wei-Xing, 2018. "The cooling-off effect of price limits in the Chinese stock markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 505(C), pages 153-163.
    • Handle: RePEc:eee:phsmap:v:505:y:2018:i:c:p:153-163
    DOI: 10.1016/j.physa.2018.03.066
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    References listed on IDEAS

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    1. Wu, Ting & Wang, Yue & Li, Ming-Xia, 2018. "Price performance following stock’s IPO in different price limit systems," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 490(C), pages 953-966.
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    Cited by:

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    2. Zhang, Xiaotao & Li, Xinxian & Hao, Jing & Li, Peigong, 2023. "Price limit change and magnet effect: The role of investor attention," Finance Research Letters, Elsevier, vol. 53(C).
    3. Gao-Feng Gu & Xiong Xiong & Hai-Chuan Xu & Wei Zhang & Yongjie Zhang & Wei Chen & Wei-Xing Zhou, 2021. "An empirical behavioral order-driven model with price limit rules," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-24, December.
    4. Sifat, Imtiaz Mohammad & Mohamad, Azhar, 2020. "A survey on the magnet effect of circuit breakers in financial markets," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 138-151.
    5. Bao, Zhengyang & Kalaycı, Kenan & Leibbrandt, Andreas & Oyarzun, Carlos, 2020. "Do regulations work? A comprehensive analysis of price limits and trading restrictions in experimental asset markets with deterministic and stochastic fundamental values," Journal of Economic Behavior & Organization, Elsevier, vol. 178(C), pages 59-84.

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