Speculative markets and the effectiveness of price limits

Abstract

The aim of this paper is to study the effectiveness of price limits in speculative markets. We construct a nonlinear stochastic asset pricing model in which traders rely on technical and fundamental analysis to determine their orders. The dynamics of the model mimic stylized facts such as the emergence of bubbles, excess volatility, fat tails for returns or volatility clustering quite well. Using this model as a laboratory, we find that price limits have the potential to reduce both volatility and deviations from fundamentals. The more traders lend themselves to trend-extrapolating behavior, the better price limits work. (C) 2003 Elsevier B.V. All rights reserved.