The Impact of Price Limits on Stock Volatility and Price Delay: Evidence from China

Abstract

This paper uses a difference-in-difference methodology to tackle the identification issue in estimating price limits’ impacts on market efficiency. Examining the Special Treatment policy in China, I show that 5-basis-point tightening in daily price limits (from ± 10% to ± 5%) significantly reduces annualized volatility by 6.5 basis points (t =5.00) yet increases price delay by 63% from the previous year (t =7.40). Trading activity and liquidity significantly decrease under new limits but return increases by equal-weighted average of 27% (t = 3.22) in 12 months. Evidence suggests that in the long-run price limits are effective in reducing volatility and improving firm value yet causing delayed price discovery and lower liquidity.

Keywords: China, price limits, emipirical asset pricing, liquidity, market efficiency, volatility

JEL Classification: G10, G12, G14, G15