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The puzzle of privately-imposed price limits: are the limits imposed by financial exchanges effective?

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  • Reiffen, David
  • Buyuksahin, Bahattin

Abstract

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.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 35927.

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Date of creation: Dec 2010
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Handle: RePEc:pra:mprapa:35927

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Related research

Keywords: Price limits; Regulatory evasion; Put-call parity; Satellite market; Price discovery;

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References

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  1. Sanford J. Grossman, 1989. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," NBER Working Papers 2357, National Bureau of Economic Research, Inc.
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