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Why Do Price Limits Exist in Stock Markets? A Manipulation-Based Explanation

Authors


  • We are grateful to an anonymous referee, Anocha Aribarg, Bruce Bender, Joon Chae, Haiwei Chen, Kee Chung, John Doukas (the editor), Harald Henke, Rob Nelson, John Nofsinger, Atanu Sinha, Avanidhar Subrahmanyam, Qinghai Wang, and to various stock market officials from around the world (officials from two exchanges in particular) for discussions and/or comments on earlier versions of this paper. Choonsik Lee provided superb research assistance. The usual disclaimer applies. Correspondence: Kenneth A. Kim.

Abstract

Numerous stock market regulators around the world impose daily price limits on individual stock price movements. We derive a simple model that shows that price limits may deter stock market manipulators. Based on our model's implications, we predict that regulators impose price limit rules for markets where the likelihood of manipulation is high. We present empirical evidence consistent with this hypothesis. Our study is the first to formally propose a manipulation-based rationale for the existence of price limits in stock markets.

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