Empirical Research Of Impact On Trade Efficiency Of Price Limits Based On Chinese Stock Market

Volatility is the basis of the security markets’normal operation. But when investors lack rationality, it will lead to huge price volatility. In this case, it will not only affect the allocation of resources, but also affect the entire economic and social stability. For the benefit of investors, exchanges of every country have designed policy to suppress the excess volatility. Volatility can be divided into two situations:fundamental volatility and temporary volatility. Fundamental volatility refers to the changes of price due to the unexpected securities’ inner factors. Temporary volatility caused by the behavior of noise traders. Based on the division, policy makers should suppress temporary volatility, rather than impose restrictions on fundamental volatility.Price limits have been widely used as one of the measures to stabilize the price. However, since the implementation of the measure, the academic debate about the impact on the security markets never stops. Scholars at home and abroad put a lot of researches on the impact of the measures about price, volatility and liquidity.From the results of the study, supporters say that it has at least three positive effects for maintaining the order of the markets. Firstly when the price reaches the price limits, especially during abnormal trading, it provides investors enough time to digest information. Secondly in the current Chinese security markets, it prevents extreme price movements so that uncertain loss for the investors is lower. Thirdly for margin trading market, it ensure the safety of the settlement systems. Of course, it is a low cost and easy way to implement the protection for the markets’ supervisors. The price limits affect the market efficiency in at least three aspects by opponents’ views. Firstly, makers manipulate the market through the irrational behavior of the noise traders. Secondly, it hinders the process of price discovery through mechanically setting the price limits. The order imbalance can not be corrected until the next trading day or longer. Thirdly, it reduce investors’ willingness to invest because lack of liquidity of the market. In this paper, we use the empirical method to find out the impact of price limits in short-term and long-term based on our stock market. For the short-term effect, we use the event study method and comparative groups to examine volatility spillovers effect、hindering trade effect and delaying price discovery effect. For the long-term effects, using data of two periods of no price limits and price limits, we compare stock market liquidity and volatility before and after, then we divide the time with bull and bear of the market respectively for further research.This article is organized as follows:The first part is the preface which summarizes the research ideas and put forward advantages and disadvantages.The second part summarizes the existing articles about the impact on the stock’s market efficiency of price limits, foreign and domestic literature are elaborated. For the part of foreign literature, we divide the theoretical and empirical research of the article and for the domestic literatures, we summarize empirical research on the Shanghai and Shenzhen, and on the Taiwan stock market.The third part we introduce price limits in details including the development process about the price limits of the Shanghai、Shenzhen and the Taiwan Stock Exchange.The fourth part we examine short-term effects,such as volatility spillover effects, price discovery delaying effects and hindering the transaction effects.We divide the stock by price fluctuations into three groups (up or down to price limits of,prices change in the9%-10%and8%to9%as the two reference groups).In order to prove that the price limits group’s performance is different from reference groups, and these differences can be attributed to the price limits. The basic idea is that these differences can not be attributed to price limits directly because the difference of the price change, while there is no difference between the two reference groups, we can get to our conclusion. The approach requires not only the differences between reference groups but also no difference between the reference groups. If any one of the two conditions can not be met, we can not get the ideal conclusions. When the price up to the daily price limit in the short term, volatility of the next day is higher than the normal level, while when the price is down to the price limit, volatility after three days is higher than normal levels, the results indicate the presence of volatility spillovers and the asymmetric impact on price limits for the rise and fall.The stocks which reach the upper price limit continue to rise at high probability, meanwhile the stocks which reach the lower price limit countinue to fell at much higher probability. The result proves the presence of delaying price discovery effect. The day after the stock reach the upper price limit,turnover growth rate is extraordinary higher than the reference groups which decrease to a negative value, indicating that the price limits hinder the stock market fluidity.The fifth part we examine the long-term effect on the stock market of price limits. In the long run, it does not reduce the market trading, but increase the liquidity of the market. Whether in a bull or bear market, it reduces the liquidity of the market, but by introducing the stock index futures, the liquidity of the market increases to make up for the adverse effects. The implementation of price limits reduces the volatility of the stock market which is evident both in the bear market or a bull market. So in the long run, price limits as a whole do not exacerbate the volatility of the market and hinder the market transactions, but improve market efficiency.The sixth part we get to the conclusion and provide some suggestions. Overall, impact on the stock market of the price limits in the short-term and long-term efficiency is contradictory, but it is precisely because of trading restrictions in the short run, giving investors a cooling-off the time to suppress abnormal price fluctuations in the long term. Empirical results show that the short-term liquidity disruption in the long-term do not affect the liquidity of the stock market as a whole. Therefore, the authors believe that there is no sufficient evidence that we should cancel price limits in the developing countries like ours.This paper has three points of innovation:Firstly, we use the recent years’ data to analyze the impact of price limits on trade efficiency which makes the conclusion timeliness, and we uses longer data compared with the previous literature which makes the conclusion more persuasive; Secondly, we distinguish rise and fell of the price movement during research on short-term effects, and pay attention to the links between the short-term effects; Thirdly, we analyze the impact on both Bull and Bear markets in the long-term study, and in the division of time we insert the time of the introduction of stock index futures which is different from the previous literature.The inadequacies of this article are:we delete the data of continuous ups and downs made the conclusion of the article not universal; in the short-term study, we use comparative method which requires that there is no significant difference between the reference group, otherwise the conclusion is not descriptive. There are some situations in the course of the study that the difference between the reference group is huge.So interpretation of the conclusions is weakening.In the long-term study, we compare the two periods before and after the price limits which there is a problem that the difference is not necessarily caused by the price limit. We do not continue to explore, roughly came to the conclusion, and expect improvement in the later study.