Department of Finance

1. The performance of China's stock market price limits: noise mitigator or noise maker?

Author:Juan, T;Wu, YY;Zhang, JY


Abstract:Purpose - The purpose of this paper is to re-examine the effectiveness of price limits on stock volatilities in China over a more recent time period spanning from 2007 to 2012. The motivation stems from the fact that very high stock market volatilities are observed in China and we are sceptical of the volatility mitigating effect claimed by advocates of price limits. Design/methodology/approach - The effectiveness of price limits on volatilities is examined using an event study methodology and within an expanded framework of volatility-volume relationships. The sample stocks include the 300 component stocks of the CSI300 Index. Findings - Both event study and regression analysis suggest that price limits exaggerate market volatilities by causing volatility spillovers. The destabilising effect is much more pronounced for small firm stocks and when the market falls. In addition to the informational source of volatilities (represented by volume), price limits create another non-trivial frictional source of volatilities in China's stock market. Originality/value - This research is the first to re-examine the price limit effect in China's stock market in an expanded framework of volatility-volume relationships. It identifies price limits, in addition to information, as another non-trivial frictional source of volatilities. The findings derived from a recent sample period confirm the conventional view of inefficiency of price limits raised by Fama (1989) and provide evidence in support of the pervasive trend of stock market deregulations.
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