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Are price limits on futures markets that cool? Evidence from the Brazilian Mercantile and Futures Exchange

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  • Fernandes, Marcelo
  • Rocha, Marco Aurélio dos Santos

Abstract

This paper investigates the impact of price limits on the Brazilian futures markets using high frequency data. The aim is to identify whether there is a cool-off or a magnet effect. For that purpose, we examine a tick-by-tick data set that includes all contracts on the S�o Paulo stock index futures traded on the Brazilian Mercantile and Futures Exchange from January 1997 to December 1999. The results indicate that the conditional mean features a floor cool-off effect, whereas the conditional variance significantly increases as the price approaches the upper limit. We then build a trading strategy that accounts for the cool-off effect in the conditional mean so as to demonstrate that the latter has not only statistical, but also economic significance. The in-sample Sharpe ratio indeed is way superior to the buy-and-hold benchmarks we consider, whereas out-of-sample results evince similar performances.

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Paper provided by FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil) in its series Economics Working Papers (Ensaios Economicos da EPGE) with number 630.

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Date of creation: 01 Nov 2006
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Handle: RePEc:fgv:epgewp:630

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  1. Wooldridge, Jeffrey M., 1991. "On the application of robust, regression- based diagnostics to models of conditional means and conditional variances," Journal of Econometrics, Elsevier, Elsevier, vol. 47(1), pages 5-46, January.
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  5. Cho, David D. & Russell, Jeffrey & Tiao, George C. & Tsay, Ruey, 2003. "The magnet effect of price limits: evidence from high-frequency data on Taiwan Stock Exchange," Journal of Empirical Finance, Elsevier, Elsevier, vol. 10(1-2), pages 133-168, February.
  6. Timo Teräsvirta & Marcelo C. Medeiros & Gianluigi Rech, 2006. "Building neural network models for time series: a statistical approach," Journal of Forecasting, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 25(1), pages 49-75.
  7. Dhrymes, Phoebus J., 1986. "Limited dependent variables," Handbook of Econometrics, Elsevier, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 3, chapter 27, pages 1567-1631 Elsevier.
  8. Kodres, Laura E & O'Brien, Daniel P, 1994. "The Existence of Pareto-Superior Price Limits," American Economic Review, American Economic Association, American Economic Association, vol. 84(4), pages 919-32, September.
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  11. Brennan, Michael J., 1986. "A theory of price limits in futures markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 16(2), pages 213-233, June.
  12. Subrahmanyam, Avanidhar, 1994. " Circuit Breakers and Market Volatility: A Theoretical Perspective," Journal of Finance, American Finance Association, American Finance Association, vol. 49(1), pages 237-54, March.
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  14. Lee, Tae-Hwy & White, Halbert & Granger, Clive W. J., 1993. "Testing for neglected nonlinearity in time series models : A comparison of neural network methods and alternative tests," Journal of Econometrics, Elsevier, Elsevier, vol. 56(3), pages 269-290, April.
  15. Kim, Kenneth & Rhee, S Ghon, 1997. " Price Limit Performance: Evidence from the Tokyo Stock Exchange," Journal of Finance, American Finance Association, American Finance Association, vol. 52(2), pages 885-99, June.
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Cited by:
  1. Wong, Woon K. & Chang, Matthew C. & Tu, Anthony H., 2009. "Are magnet effects caused by uninformed traders? Evidence from Taiwan Stock Exchange," Pacific-Basin Finance Journal, Elsevier, Elsevier, vol. 17(1), pages 28-40, January.
  2. Wong, Woon K. & Liu, Bo & Zeng, Yong, 2009. "Can price limits help when the price is falling? Evidence from transactions data on the Shanghai Stock Exchange," China Economic Review, Elsevier, Elsevier, vol. 20(1), pages 91-102, March.

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