The effects of daily price limits on cotton futures and options trading
The New York Cotton Exchange (NYCE) imposes price limits on the trading of cotton futures, whereby the price at which cotton futures trade during a day is restricted to a band centered around the previous day's close. However, the NYCE has no such restrictions on the trading of options on cotton futures. These exchange rules allow for essentially a controlled experiment to study the market participants' responses to the price limits on futures. We show that, as a higher fraction of the trading day is constrained by the price limit, futures volume significantly decreases, options volume significantly increases, but the average aggregate volume of cotton trade remains unchanged. The empirical analysis indicates that market participants react rationally to the price limit in the futures market by transferring their trading activity to a market without price limits.
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- Brennan, Michael J., 1986. "A theory of price limits in futures markets," Journal of Financial Economics, Elsevier, vol. 16(2), pages 213-233, June.
- Don M. Chance, 1994. "Futures pricing and the cost of carry under price limits," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 14(7), pages 813-836, October.
- Richard Cantor, 1989. "Price limits and volatility in soybean meal futures markets," Research Paper 8904, Federal Reserve Bank of New York.
- Kodres, Laura E & O'Brien, Daniel P, 1994. "The Existence of Pareto-Superior Price Limits," American Economic Review, American Economic Association, vol. 84(4), pages 919-932, September.
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