The Effect of Change in Price Limit on Stock Market Volatility and Trading Volume -Evidence from Tehran Stock Exchange (TSE)

Abstract

Financial market crashes in recent decades have given rise to discussions about excessive volatility in these markets. Some authorities recommend price limits as a device to control excessive price swings, arguing that price limits can provide a cooling-off period that allows investors to re-evaluate market information and make more rational decisions during the period of extreme price changes. On the other side, opponents claim that price limits cause volatility to spread out over a longer period of time, harming the price discovery process and liquidity of the market. These different opinions illustrate the lack of consensus on the effectiveness of price limits. This study empirically investigates the effectiveness of price limits by examining stock market characteristics (such as volatility and volume) around the revision of price limit (from 5% to 2% in 1384 and from 2% to 3% in 1387) on the Tehran Stock Exchange (TSE). The main finding of this study is that for the cross-section of stocks, the change in price limits is negatively related to the change in (weekly) volatility and trading volume. That is, price limit mechanism could not effectively reduce volatility in TSE. The second finding of this study is that the effects of the revision in price limit have no relation with size.

Keywords

• price limit
• volatility
• volume
• size
• tehran stock exchange