Price limits and volatility Saikat Sovan Deb a , Petko S Kalev b, ⁎ ,1 , Vijaya B Marisetty c a Deakin Business School, Department of Finance, Deakin University, Geelong, Australia b Centre for Applied Financial Studies, School of Commerce, University of South Australia, Australia c School of Economics, Finance, and Marketing, RMIT University, Australia article info abstract Article history: Received 28 November 2016 Accepted 2 December 2016 Available online 7 December 2016 This study provides new evidence on efficacy of daily price limit rules. We propose use of pro- pensity score matching techniques to reduce sample selection bias in widely used Kim and Rhee (1997). Using data from the Tokyo Stock Exchange over a period of 5 years from January 2001 to December 2005, this study shows that price limit rules work quite efficiently for lower limit hits as there is no evidence of volatility spill-over. We also find that daily price limits have differential effects on permanent and transitory components of daily volatility. Our study re- ports evidence of spill-over of permanent volatility. However, we find price limit successfully curbs the transitory volatility on the post limit hit days. © 2016 Published by Elsevier B.V. Keywords: Price limit rules Permanent and transitory volatility Post limit hit day Propensity score matching Volatility spill over 1. Introduction Effectiveness of rule based trading halt mechanisms such as circuit breakers, trading collars and price limits has been frequent- ly debated (see for example—Fama, 1989; Lehmann, 1989; Miller, 1989; Subrahmanyam, 1994; Kim and Rhee, 1997; Harris, 1998; Phylaktis et al., 1999; Bildik and Elekdag, 2004; Chan et al., 2005; Deb, Kalev & Marisetty, 2010 & 2012; Kim et al., 2013; Farag, 2013 & 2015; and Goldstein, 2015). Over time, circuit breakers and price limits has been used in several financial markets, how- ever fresh discussions on these rule based trading halts resurfaced since the May 2010 Flash Crash in US market. In this paper we investigate impact of price limits on equity market volatility. Kim and Rhee (1997) analyse the relationship between price limits and volatility in the Tokyo Stock Exchange. The authors observe that price limits causes volatility spill over to the following trading days and hence they conclude that price limits are not effective in reducing volatility. However, studies by Lee and Kim (1995) and Berkman and Lee (2002) on Korean market re- port that price limits reduce volatility. Therefore the verdict on efficacy of price limits is far from clear. In this paper, while building on Kim and Rhee's (1997) methodology we consider an improved research design. The prior lit- erature on price limit compares average volatility of limit hitting stocks against average volatility of non-price limit hitters around limit hit events (Kim and Rhee, 1997). On the other hand, Kim and Limpaphayom (2000) observe that fundamental characteristics of frequent limit hitting stocks are different from non-limit hitting group. Hence, when average volatility persistence of limit hit- ters is significantly greater than volatility persistence in non-limit hitting group, the results of volatility spill over test in Kim and Rhee (1997) may only reflect the difference in volatility persistence of between the test and the control group, and may not Pacific-Basin Finance Journal 45 (2017) 142–156 ⁎ Corresponding author at: Director Centre for Applied Financial Studies, School of Commerce, UniSA Business School, Way Lee Building, Room WL3-41, City West campus Internal mail CWE-31, Postal address GPO Box 2471, Adelaide, South Australia 5001, Australia. E-mail address: petko.kalev@unisa.edu.au (P.S. Kalev). 1 http://people.unisa.edu.au/Petko.Kalev. http://dx.doi.org/10.1016/j.pacfin.2016.12.002 0927-538X/© 2016 Published by Elsevier B.V. Contents lists available at ScienceDirect Pacific-Basin Finance Journal journal homepage: www.elsevier.com/locate/pacfin