Analyzing Price Limit Policy Under a Theoretical Framework
This paper provides a theoretical framework to study the effects of implementing price limit policy on price movements and trading behaviors. Due to the high difficulty of isolating effects of price limits in empirical data, it is useful to develop a model to simulate the theoretically possible effects of enforcing price limits on stock trading. In addition, we offer two ways of expanding the model into 2-segments that could differentiate the effects of having price limits on individual investors from institutional investors. According to our model, hitting price limits can be summarized to eight different short-term scenarios and each results in different effects on the direction of price movement and short-term liquidity in the next trading period. Besides offering a theoretical perspective on price limit effects, our model provides two new ways of approaching price limits in stock market: i) it can be simplified to the identification of the eight types of patterns and ii) it can be transformed to a study of investor composition and their behaviors on risk bearing with the presence of price limits.