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Test of the overreaction theory of price limits in futures markets

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Test of the overreaction theory of price limits in futures markets

Zhu, Yongzhong (2006) Test of the overreaction theory of price limits in futures markets. Masters thesis, Concordia University.

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Abstract

In this thesis we examine the effects of daily price limits on futures trading and test the overreaction theory of price limits in futures markets. The overreaction theory states that price limits can be used to correct the overreaction in the market and then reduce the excess volatility. This thesis studies both corn and soybean futures on the Chicago Board of Trade during a twelve year period from July l, 1982, to November 30, 2004, and conducts tests to see if the futures price volatility is reduced during the day or days after limit hits in futures markets. We use event study methodology to compare matched samples. Our tests find little evidence supporting the overreaction theory. On the contrary, our results show strong spillover effects and provide strong evidence indicating that price limits mainly suspend the transaction and delay the price discovery and make the market less efficient, especially when the price limit level is set too narrow. Further tests indicate that the overreaction theory may work at an intra-day level. The overreaction built up is reduced during the first several minutes after a price limit is hit. Results also show that overreaction is just a minor effect and the overreaction theory only depicts a small part of the picture of how price limits work. We propose that in most situations where the optimized limit level is unknown, we should set limit levels wider rather than narrower, to avoid delayed transactions and inefficient market prices

Divisions:Concordia University > John Molson School of Business
Item Type:Thesis (Masters)
Authors:Zhu, Yongzhong
Pagination:viii, 56 leaves ; 29 cm.
Institution:Concordia University
Degree Name:M. Sc. Admin.
Program:John Molson School of Business
Date:2006
Thesis Supervisor(s):Shanker, Latha
ID Code:8991
Deposited By:Concordia University Libraries
Deposited On:18 Aug 2011 14:41
Last Modified:18 Aug 2011 14:41
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