A Preliminary Model for Estimating the Impact of Price Limits on Taiwan Stock Exchange1

In many emerging stock markets, price limits are imposed on the magnitude of daily price movements. Price limit advocates claim that such limits serve as "circuit breakers" and decrease stock price volatility. Critics argue that the limits cause supply and demand imbalances in trading. Consequently, they prevent immediate corrections in price and increase the volatility of the opening return on the subsequent trading day. This is known as the volatility spillover hypothesis. The empirical results on the impact of price limits in the stock market appear mixed. Furthermore, research using high frequency data directly from an emerging stock market where daily price limits are implemented is rare. Our study uses 5minute intra-day price data from the Tai Wan stock exchange, where a daily price limit of 7% is imposed for all traded stocks. We consider the spillover e ect of price limits as the e ect that, given the price hitting the limits and staying at the limits for a certain amount of time, how much the next day's rst ve-minute(ten-minute, fteen-minute...) volatility is elevated. We nd signi cant evidence for this e ect, after controlling for the company's speci c overnight e ect. Contrary to what might be expected after the emergence of a consensus price, the period immediately after a trading cessation is characterized by higher levels of volatility. We conclude that the daily price limits in TSE are ine ective in preventing over-reaction.