The effectiveness of price limits: some new evidence from options market

Abstract

Previous studies on the effectiveness of price limits suffer from the problem of being unable to observe the true asset price in the absence of price limit. This paper employs a new approach to investigate the effectiveness of the price limit regulation rules by using data of the Taiwan derivatives warrants, which are more flexible to reflect underlying asset's "true" value when the underlying asset price hits the limits. We examine whether options provide price discovery function for the opening price of the next trading day after a limit-lock day. Our empirical results show that option market provides useful price discovery information for the cases that underlying asset prices hit the upper limits. The results are especially significant for warrants issued by high credit rating financial institutes.