The cooling-off effect of price limits in the Chinese stock markets

TL;DR

This study investigates the cooling-off effect of price limits in Chinese stock markets, showing it stabilizes markets and is influenced by investor types and market conditions through analysis of high-frequency trading data.

Contribution

It provides empirical evidence of the cooling-off effect in Chinese markets and explores its dynamics, differences between market states, and investor roles, which was previously underexplored.

Findings

Cooling-off effect exists for both up-limit and down-limit hits.

Down-limit hits exhibit a stronger cooling-off effect than up-limit hits.

Professional and institutional investors positively influence the cooling-off effect.

Abstract

In this paper, we investigate the cooling-off effect (opposite to the magnet effect) from two aspects. Firstly, from the viewpoint of dynamics, we study the existence of the cooling-off effect by following the dynamical evolution of some financial variables over a period of time before the stock price hits its limit. Secondly, from the probability perspective, we investigate, with the logit model, the existence of the cooling-off effect through analyzing the high-frequency data of all A-share common stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange from 2000 to 2011 and inspecting the trading period from the opening phase prior to the moment that the stock price hits its limits. A comparison is made of the properties between up-limit hits and down-limit hits, and the possible difference will also be compared between bullish and bearish market state by dividing the whole period into three alternating bullish periods and three bearish periods. We find that the cooling-off effect emerges for both up-limit hits and down-limit hits, and the cooling-off effect of the down-limit hits is stronger than that of the up-limit hits. The difference of the cooling-off effect between bullish period and bearish period is quite modest. Moreover, we examine the sub-optimal orders effect, and infer that the professional individual investors and institutional investors play a positive role in the cooling-off effects. All these findings indicate that the price limit trading rule exerts a positive effect on maintaining the stability of the Chinese stock markets.