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Rational price limits in futures markets: tests of a simple optimizing model

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  • Ackert, Lucy F.
  • Hunter, William C.

Abstract

This paper tests a simple descriptive model of optimal futures price limits under the assumption that futures exchanges operate under the criterion of minimizing the long‐run average cost associated with market making. This cost is composed of a “running cost,” reflecting the expenses associated with providing for the continuous operation of the market, and a cost associated with trading interruptions resulting from limit moves. The model implies that the optimal daily limit increases with the cost of trading interruptions and decreases with running costs and that at the margin, the limit should be set so as to just balance these costs. The model is tested using price limits in place on ten contracts traded on the Chicago Board of Trade between 1977 and 1979. The econometric results indicate that for seven of the ten contracts examined, the actual level of the daily price limit is, on average, equal to that implied by the optimizing model.
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  • Ackert, Lucy F. & Hunter, William C., 1994. "Rational price limits in futures markets: tests of a simple optimizing model," Review of Financial Economics, Elsevier, vol. 4(1), pages 93-108.
    • Handle: RePEc:eee:revfin:v:4:y:1994:i:1:p:93-108
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    Cited by:

    1. Shanker, Latha & Balakrishnan, Narayanaswamy, 2005. "Optimal clearing margin, capital and price limits for futures clearinghouses," Journal of Banking & Finance, Elsevier, vol. 29(7), pages 1611-1630, July.
    2. Zhang, Xiaotao & Wang, Ziqiao & Hao, Jing & He, Feng, 2022. "Price limit and stock market quality: Evidence from a quasi-natural experiment in the Chinese stock market," Pacific-Basin Finance Journal, Elsevier, vol. 74(C).
    3. Levy, Tamir & Qadan, Mahmod & Yagil, Joseph, 2013. "Predicting the limit-hit frequency in futures contracts," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 141-148.
    4. Tang, Siyuan, 2023. "Price limit performance: New evidence from a quasi-natural experiment in China's ChiNext market," International Review of Financial Analysis, Elsevier, vol. 89(C).

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