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Journal of Financial Services Research 12:1 520 (1997)

# 1997 Kluwer Academic Publishers

Do Daily Price Limits Act as Magnets? The Case of


Treasury Bond Futures
MARCELLE ARAK
University of Colorado at Denver
RICHARD E. COOK
University of Colorado at Denver

Abstract
This article examines price behavior in the U.S. Treasury bond futures market in the mornings after large
overnight price moves, using data from 1980 to 1987. The article tests whether price behavior is affected by
proximity to a price limit, and whether the effect is a magnet effect or a calming effect. In that period, the price
tends to reverse direction after the morning open, and the reversal appears to reect a calming effect of the price
being close to the limit. An alternative hypothesisthat morning price behavior reects the overnight price
change rather than proximity to the price limit per seis also tested, and does not perform as well in explaining
price behavior.

The use of ``circuit breakers'' in nancial markets has generated a great deal of
discussion, particularly since the crash of 1987. The Brady Commission Report (1988,
p. 66) argued that ``. . . circuit breakers cushion the impact of market movements.''
However, some academics and market participants disagree. Ferguson (1988, p. 15),
writing about daily price limits, one type of circuit breaker, argues that ``[a]nyone who
thinks they might want to sell, or, worse, need to sell, will be very skittish in a market that
can be closed. These investors will sell at the rst sign of conditions that have been
associated with previous closing. . . . The most predictable result of a policy of closing a
market is to make the market more unstable and chaotic than before.'' This view suggests
that limits have a destabilizing or ``magnet'' effect that acts to pull prices toward the
limit, rather than a stabilizing effect that calms market movements.
Whether circuit breakers are helpful or harmful to the functioning of markets is clearly
an important issue. Yet, despite considerable discussion, it is an issue that has not been
denitively answered by empirical work.
In this article, we examine one type of circuit breakerdaily price limitsthat is used
in many futures markets. In markets where limits are used, they are imposed by the
exchange, and are set at the previous settle plus or minus a xed number of points.
Although a few articles in the academic literature have empirically investigated the effect
of price limits on price behavior, there is little agreement on the effects of these limits. Our
purpose in this article is to set up an analytical framework and examine evidence from
eight years of U.S. Treasury bond futures price behavior.
Analyzing the morning behavior after large overnight price moves, we nd that

MARCELLE ARAK AND RICHARD E. COOK

proximity to the limit tends to cause a small price reversal. This is consistent with the daily
price limit acting as a stabilizer in that market. Moreover, our statistical analysis supports
the view that it is the limit per se that causes the reversal, rather than a correction of market
overreaction.
The plan of this article is as follows. The next section discusses the theory and relevant
empirical literature; section 2 then sets out our model and describes the data. The third
section presents our empirical ndings, and section 4 discusses our conclusions.
1. Theory and related literature
The literature provides little theory on how daily price limits can affect price behavior.1
Indeed, it is difcult to develop such a theory within the context of efcient markets. The
newer view of ``noise traders'' affecting prices in the short run, however, allows enough
scope to develop a theory that explains the effect.2
One explanation of how daily price limits destabilize price behavior is based on the
hypothesis that some investors believe in the existence of price trends. Noise traders,
seeing an apparent price trend, can act in a way that produces a magnet effect. Consider,
for example, traders who believe that the price is in an upward trend. As long as a price
limit is not near, they might be inclined to wait for some clarication before buying, since
a wait poses little difculty. However, traders know that once the price reaches the limit,
they could be prevented from buying, since the market consensus price might be above the
limit. By the time the new day opens, with new price limits that are wide enough to
encompass the new equilibrium price, the price could be substantially higher. Therefore, to
avoid being shut out of the trend, traders who think that the upper limit will be reached
might buy sooner. This tends to accelerate price changes as the limit is approached, and
thus the limit creates a magnet effect. (Exactly the reverse occurs at the lower limit, with
traders rushing to sell sooner.)
Day traders' behavior provides another possible cause of a magnet effect: Some market
participants do not want to hold their position overnight. If they are short (long) during the
day, they are buyers (sellers) at the close. If they are short and the new equilibrium price is
above the upper limit, they are unable to buy. (There would be no sellers at the upper price
limit, which is below the equilibrium price.) Consequently, such day traders might offset
short positions more quickly as the upper limit is approached, for fear that they could be
shut out when the upper limit is reached. On the other hand, day traders who are net long
would try to sell as the price approached the lower limit. At either limit, then, some day
traders will adjust their position because the limit is near. Their efforts to do so can cause
prices to accelerate as the limit is approached.
A stabilizing effect, on the other hand, can also be driven by day traders' behavior.
Those who believe that the market is trending upward (downward) want to be long (short).
If the price is near the limit, however, the potential for gain within the trading day is
limited, while the loss potential remains large. Although the trend could continue the next
trading day, day traders try to avoid holding overnight positions. Near the limit, then, those
traders who have become bullish (bearish) have less incentive to buy (sell), thereby
reducing demand (supply) and slowing the price rise (decline).

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

Thus, it is possible that daily price limits can either calm overreaction or cause it. Both
of these views contrast with the more traditional view that the only impact of price limits
occurs when a new equilibrium price is outside the allowed trading range. In this case, the
limit prevents prices from moving to the new equilibrium until the limit is reset.
While there are no formal theories of how daily price limits affect price behavior,
several studies have empirically examined price limits and price behavior. The literature
has also addressed market behavior after large price moves. If markets tend to overreact,
price limits could damp the overreaction; thus, limits could be stabilizing in such markets.
Evidence indicates that some markets do overreact at times. However, if limits exist in
these markets, the overreaction can be confounded with the effects of limits.
The signicance of daily price limits for price behavior has been examined through
laboratory experiments and empirical market studies. Laboratory experiments suggest that
limits affect the behavior of student subjects (e.g., Isaac and Plott, 1981; Coursey and Dyl,
1988). In the CourseyDyl article, price limits are set at 4% above and below the previous
session's price, a realistic analog to daily price limits in the futures markets. In general, the
limits appear to retard the movement to a new equilibrium, making the market calmer,
albeit less efcient. However, it is not known whether student subjects perform like
experienced traders.
Empirical research has examined how markets react to trading halts, including halts
caused by daily price limits. For a discussion of normal trading halts, see Brock and
Kleidon (1992) and Gerety and Mulherin (1990). Trading halts in markets with
asymmetric information have been discussed by Spiegel and Subrahmanyam (1994).3
Studies of market behavior include several articles by Ma, Rao, and Sears (1989a, b),
who use daily and intraday data on selected futures contracts to examine the price behavior
after the contract hits a price limit. They nd a tendency for a price reversal on the day
after the limit is reached. This reversal occurs in both T-bond futures and agricultural
futures. Price reversal suggests that overreaction occurred on the day on which the limit
was hit. In interpreting these results, note that overreaction by itself is consistent with
either view on the role of price limits; without the limit, prices might have moved further
that day, suggesting that the limit damped the overreaction. On the other hand, the limit
could have magnied the price movement, thus causing some of the overreaction.
Kuserk, Moriarty, Kuhn, and Gordon (1989), using transactions data on the T-bond
contract for 1986 and 1987, and on soybean and corn contracts for MayJune 1988,
examine price behavior during the day the price limit is approached. They compute
average and median time per tick, when the price is within 15% of the limit and also at
other randomly chosen times. Kuserk et al. nd that price change per second is no faster
when the price is close to the limit than at other times. Also, their tests on runs and
reversals in price movements do not strongly support a magnet effect. The tests in Kuserk
et al. are well constructed; a limitation of their study, however, is that, for bonds, the data
for these tests are not plentiful. For most of their sample period, the 15% cutoff represents
a price different from the previous close by more than 2.5 points. (Since September 1986,
the daily price limit on T-bonds has been the previous settle plus or minus three points.)
While several studies have examined price behavior in the vicinity of price limits, the
literature has not addressed the issue of prices approaching a limit only after a large price
move. This complicates the interpretation of price behavior near limits. Studies have found

MARCELLE ARAK AND RICHARD E. COOK

that the market's behavior after a large price change can differ from its behavior at other
times.
In this second strand in the literature, a number of articles study initial and subsequent
reaction to news in order to address the issue of overreaction versus underreaction. Ma,
Dare, and Donaldson (1990) examine whether initial large price changes are
``appropriate'' in magnitude. They examine the daily autocorrelation of futures prices
following a ``signicant event,'' which they dene as a price change of at least two
standard deviations. Any signicant autocorrelation suggests that the market is still
reacting on the subsequent day. In the case of agricultural commodities, a price reversal on
the subsequent day is typical, which suggests that prices initially tend to overreact. In the
case of nancial futures, in contrast, price changes tend to be in the same direction on the
subsequent day. This suggests that prices in nancial futures markets tend to underreact
initially to signicant events. Ma, Dare, and Donaldson conclude that prices do not adjust
within one day to new information. (They do not attempt to explain the difference in
behavior between commodity futures and nancial futures.)
Brown, Harlow, and Tinic (1988) trace the price performance of individual stocks for
more than a year after major news. They dene ``news'' as an abnormal return of at least
2.5%, measured against a market index. This denition includes anything that moves the
price substantially, whether it is the actual release of new information or the reassessment
of the outlook based on information previously available. After a big initial upward price
move, the stock price continues to rise and produces above-normal positive returns
(apparent initial ``underreaction''). After a large negative return, the stock price trends
upward, and again produces above-normal positive returns (apparent initial ``overreaction''). Brown et al. argue that the above-normal rates of return after both good and
bad news are compensation for the increase in uncertainty generated by a surprise.
Gay, Kale, Kolb, and Noe (1994) explore whether large commodity price moves during
one day are associated with a price move that night and during the following day (the day
on which the Wall Street Journal (WSJ) reports the news that was released to the market on
the previous day). Following a large drop in price, they nd that the price declines further
during the subsequent overnight interval and then reverses during the following trading
day. They nd this overnight overreaction for a wide range of commodity futures. Gay
et al. interpret the overnight decline and subsequent reversal as a reaction to the report of
downward movement on the previous day, even though the WSJ report itself did not
convey any information that was not already known to the market on the previous day.
Some have interpreted the overreaction evidence as supporting the stabilizing role of
daily price limits. While overreaction (without limits) offers the potential for price limits
to act as stabilizers, overreaction in markets with price limits raises the possibility that the
overreaction might actually have been caused by the limits. This article provides an
empirical framework for distinguishing the effects of price limits from those of
overreaction.
2. The model and data
To date, the empirical literature does not give a clear answer on whether limits stabilize or
destabilize. Part of the problem is that the studies have not set up appropriate models to test

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

the effect of limits. The studies that test directly for the effect of price limits use relatively
small data sets and reach different conclusions. Moreover, none of the studies has sought
to disentangle the effects of prices being close to the limit from the effects of the news that
brought them to that limit.
We set up two empirical models to directly test the effect of limits, and to distinguish
between the effect of the limit and that of news. The two modelsone focused on daily
price limits, the other on newsare as follows:
DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  EVENING;

DP b0 b1  S  NEWS b2  S  EVENING;

and
where variables are dened as follows and discussed in more detail following the sample
description:
DP: price change over a ve-minute interval at the start of morning trading (prices are
measured in decimals),
S: dummy variable, sign of overnight price change: 1 if overnight change was
positive, 1 if negative,
CTL (closeness to the limit): inverse of distance from limit at open, described below,
NEWS: square of the overnight price change, described below,
LMQ: dummy variable, 1 in last month of quarter when no limits apply, 0 otherwise,
and
EVENING: dummy variable: 1 after introduction of evening trading session, 0
before.4
There are four contracts per year, one expiring in the last month of each quarter. We
examine the price behavior on the near contract, so that each contract is followed for the
last three months of its life. The raw price data from Tick Data include the time and price
of every transaction in which the execution price was different from the previous price.
Note that the data do not include all transactions; trades occurring at the same price as the
previous trade are not reported. From these raw data, we compute price changes over each
of the rst six ve-minute intervals after the market opens in the morning. If there is no
transaction reported exactly at the ve-minute mark, we use the last reported price in the
ve-minute interval. Because the data report a trade only when the price differs from the
previous transaction, the absence of a reported trade at the ve-minute mark does not mean
that no transaction occurred. In fact, since this contract is very active, it is quite likely that
there was in fact a transaction within a few seconds of the ve-minute mark, a transaction
that occurred at the same price as the previously reported trade.
We examine price behavior on mornings after ``signicant'' overnight news, dened in
terms of the overnight price change. In the period from 1980 to April 29 1987, T-bond
futures were traded only during a day session that ran from 8 a.m. to 2 p.m. central time.
For this period, the close-to-open is identical to the overnight price change. A day is
included in the sample if the overnight price change from the previous day is at least twice
as large (in absolute value) as the standard deviation, computed over all overnight changes

10

MARCELLE ARAK AND RICHARD E. COOK

Figure 1. The gure shows the difference between calendar days and trading ``days,'' after the introduction of an
evening trading session on April 30 1987. The close-to-open price change is now measured from the end of the
day session to the start of the evening session of the same calendar day, rather than overnight. New price limits
take effect at the open of the evening session (start of the new trading ``day'').

in the 19801987 time period. Seventy-three days in this time period had such overnight
price changes.5
After the evening session begins, signicant overnight news is still measured as the
overnight price change. However, this is now from the last trade of the previous evening to
the rst morning trade. (This is not from close to open, since the close remained 2 p.m.
central time and the open of the ``new'' trading day became 5:20 p.m. of the same calendar
day. As noted earlier, the CBOT uses the 2 p.m. closing price to establish the following
trading day's price limit. See gure 1.) The data from this period that were available for
our sample were limited to the MayDecember 1987 period. This was obviously a volatile
period that included the 1987 crash, and large overnight moves were somewhat more
frequent than the average over the previous seven years. However, there were still only 12
days with an overnight price change of at least twice the standard deviation of the January
1980April 1987 period. The two periods together yield a sample of 85 observations.
Table 1 shows the number of observations per year for which the overnight news was
greater than 2s, and notes the months missing from our sample.6
Since the essence of a magnet effect is an acceleration as the limit is approached, we
dene ``closeness to the limit'' (CTL) as the inverse of the distance to the limit:
Table 1. Days in the 19801987 period with overnight price changes greater than 2s, the criterion for inclusion in
our sample. The standard deviation was computed over all overnight price changes, during the period with a
single trading session per day, January 1980April 1987.
Year

Observations

Missing months

1980
1981
1982
1983
1984
1985
1986
1987
Total

18
8
6
7
2
4
30
12
87

January, October, November, December


January, March, June
February, March, June

September
11

The raw data for the missing months were not available from Tick Data.

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

11

CTL 1=jprice limitj.7 With this denition, a positive coefcient on S  CTL is


consistent with the hypothesis that proximity to the limit at the open causes prices to move
more quickly towards the limit (e.g., in a positive direction, if the overnight change was
positive). Note also that the speed accelerates as the limit is approached.
In the last month of its life, which corresponds to the last month of the quarter, the Tbond contract is not subject to a daily price limit. In that month, we compute CTL by using
a hypothetical limit (as if the normal limit were in place) of two points prior to September
26 1986, and three points thereafter. The effect of having no limit is captured in the last
month of quarter dummy variable, LMQ. In (1), the coefcient b2 indicates the change in
CTL's effect when the contract is not subject to a limit. A positive (negative) b2 indicates
that, when the near contract is not subject to a limit, prices tend to continue more (less)
strongly in the direction of their overnight change. b2 0 indicates that behavior in the last
month is no different from that of months when the limit is in effect; b1 b2 0 indicates
that there is no effect of a hypothetical limit in the last month of the quarter.
Note that prices in the market for the near contract are closely related to prices for other
contract months. When behavior in one contract month is affected by limits, the effects can
spill over into the contract that has no limit. This could confound the interpretation of
LMQ.
The dummy for the existence of an evening session (EVENING) is included, because,
with the establishment of an evening trading session in April 1987, the new ``day'' with
new price limits begins at 5:20 p.m. Any market closure would be in effect only until then,
rather than until the next morning. The briefer period of closure could affect price behavior
in that market.8
A negative ( positive) coefcient on the EVENING dummy together with a positive
(negative) coefcient on CTL indicates less of a continuation (repellent) effect after the
introduction of an evening trading session, when the market closure is briefer.9
In (2), the price change is related to the overnight news rather than to the proximity to a
limit. Following the literature (e.g., Brown, Harlow, and Tinic, 1988; Ma, Dare, and
Donaldson, 1990), we dene news as the occurrence of a large price change. Thus, news
includes not only the actual release of new information to the market, but also the market's
reassessment of information already available. This approach avoids biases introduced by
an arbitrary determination of what actually constitutes news (Brown, Harlow, and Tinic).
For our analysis, the price change is measured from the last trade on the previous day to the
morning open. The variable NEWS is measured as the square of the overnight price
change. This allows large overnight changes to have a more than proportional effect on
morning price behavior.10 Brown, Harlow, and Tinic, for example, found substantially
larger above-normal returns following the largest price changes than after smaller price
changes.
A positive sign on NEWS suggests an initial underreaction overnight, while a negative
coefcient indicates an overnight overreaction. We do not include the variable LMQ in
this equation; if price behavior is a reaction to overnight news, the absence of a limit in the
last month of the quarter is relevant only because it permits moves larger than if the limit
were in effect that day.11
A potential problem exists in distinguishing the two alternative models: Proximity to the
limit at the open is (inversely) correlated with the absolute size of the overnight price

12

MARCELLE ARAK AND RICHARD E. COOK

change. Various factors, however, reduce the correlation. After a close at the limit, the
following three days' price limits are typically expanded by 50%.12 In addition, with the
advent of an evening trading session, the overnight change no longer has as close a
correlation with the distance from the limit in the morning: The new ``trading day'' begins
with the evening session on the previous day. The price limits for the next ``day'' are based
on the afternoon close, whereas the overnight change occurs during the middle of the new
trading day (see gure 1). These factors reduce the correlation between the overnight price
change and proximity to the limit the next morning.
Also, limits are removed entirely in the last month of a contract's life, although they
remain in force on the more distant T-bond contracts. If part of price behavior is a response
to the proximity to the limit, the effect should disappear in the last month of the contract.
On the other hand, if it represents a response to the size of the overnight price change, it
should be equally present in all three months of the near contract.
Furthermore, proximity to the limit changes to the extent that the price moves toward or
away from the limit after the open. If the limit exerts an inuence on the price, the
changing proximity over time should be reected in price behavior. We nd that this
change in proximity is relatively uncorrelated with the overnight price change, which
allows further separation of the two effects.
3. Results
Although (1) and (2) are designed to capture nonlinear effects, both are linear in the
transformed variables. Therefore, they are estimated using OLS. Table 2 reports results
from (1), using CTL. The coefcient on CTL is negative and signicant at the 1% level,
showing that the price tends to reverse direction in the morning after a signicant
overnight price move; the magnitude of this reversal is related to the proximity of price to
the limit. This apparent repellent effect is consistent with a stabilizing effect of the limit; it
is not consistent with a magnet effect.
In terms of magnitude, the effect is small: The coefcient on CTL is 0.0524, with a tvalue of 4.59, as shown in the rst column of table 2. Since a distance of one point from
the limit produces a CTL value of 1, while two full points from the limit gives a value of
0.5, the reversal effect of opening one point from the limit would be (1 0.5)  0.0524, or
0.026. Since one tick is 0.03125, the price reversal appears to be a bit less than one tick.
When the opening price is closer to the limit, however, the effect is stronger (see
discussion below).
It is possible that our functional form for CTL overstates the effect of the limit when the
price is distant from the limit, thus reducing the power of our tests to detect an effect of the
limit. Therefore, we use more restrictive sample selection rules to screen out small
overnight price changes.
Limiting the sample to mornings after an overnight price change of at least 3s (1.27
points) yielded a sample of 29 observations in the January 1980December 1987 period
(see columm 2). Using just these observations, the coefcient on CTL is similar in
magnitude ( 0.0528 vs. 0.0524), still indicating a reversal. However, the corrected R2
is greatly increased ( from 22.7% to 41.1%).
A futher restriction of the sample to overnight price changes of at least 3.5s (1.48

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

13

Table 2. Effect of closeness to the limit (CTL) on price behavior after the morning open, measured over the rst
ve minutes of trading.
DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  EVENING
Sample

2s

3s

3.5s

CTL

0.0524***
( 4.59)
0.0104
(0.49)
0.0316
(0.50)
0.0305
(1.25)
84
80
9.14***
25.5%
22.7%

0.0528***
( 4.02)
0.0130
(0.52)

0.0562***
( 5.80)
0.0309
(1.63)

CTL  LMQ
EVENING
CONSTANT
N
d.f.
F
R2
adj. R2

0.0230
(0.48)
29
26
10.76***
45.3%
41.1%

0.0318
( 0.69)
17
14
19.77***
73.8%
70.1%

OLS estimates of ve-minute price change regressed on independent variables; t-statistics in parentheses
(H0: bi 0; Ha: bi 6 0).
*** signicant at 0.01 level.
** signicant at 0.05 level.
* signicant at 0.10 level.
DP change in price over rst ve minutes of morning trading
CTL closeness to the limit at the open (see text for full description)
LMQ dummy for last month of quarter
EVENING dummy for existence of evening trading session
S sign of the overnight price change

points; columm 3) includes days when the opening price is usually within a half point of
the limit. The coefcient here is of slightly larger magnitude, 0.0562, with a t-statistic
of 5.80, and the corrected R2 jumps to 70.1%. The small change in the magnitude of the
coefcient on CTL suggests that our functional form is well specied.
Although the coefcients are similar in the different samples, the reversal effect is
stronger when the price is closer to the limit. A distance of 0.5 point gives a CTL value of
2, which indicates a reversal of (2 0.5)  0.0562 or 0.0843. The reversal this close to the
limit appears to be nearly three ticks.
The coefcients on LMQ, the dummy variable for the last month of quarter, are positive
but not signicant. The positive sign suggests less of a price reversal when the limits are
removed. This is consistent with the stabilizing hypothesis, although the lack of
signicance weakens this result. When the sample is restricted to large overnight price
changes (column 3), LMQ approaches signicance, having a p-value of 12.5%. Again, the
positive sign indicates less reversal in the last month of the quarter, but the lack of
signicance makes this result less conclusive. Another test of the stabilizing hypothesis is
that the effect disappears in the last month of the quarter. This test, bCTL bLMQ 0,
yields a t-value of 1.68, insignicant at standard levels (p-value of 11.5%), so we cannot
reject the null hypothesis that the repellent effect disappears in the last month of the

14

MARCELLE ARAK AND RICHARD E. COOK

quarter. This last result is consistent with the stabilizing hypothesis, while the earlier result
is ambiguous. Perhaps these mixed results reect the possibility that T-bond futures prices
on the near contract are restrained because the other contracts with limits are restrained,
thus clouding the interpretation of LMQ. In any case, the results on LMQ offer little
support either for or against the importance of daily price limits.
The EVENING dummy is not signicant, indicating that there is no change in the effect
of limits after the introduction of the evening trading session. Note that EVENING does
not appear in the regressions that are limited to larger price changes, since none of the
larger moves occurred after the introduction of an evening trading session.
In interpreting these results, two possible confounding effects must be considered. First,
it is conceivable that any effect of the limit works into the opening price, so that we do not
see the effect of the limit after the morning open. Second, since observed prices are noisy
estimates of equilibrium prices, the largest price changes are more likely to be
overreactions, leading to a reversal after the open. In that case, our sample selection
process could drive the apparent reversal effect.
If a stabilizing effect of the limit is reected in the opening price, we would expect
smaller overnight price movements, on average, when limits are in effect. This would
imply fewer observations in months that are subject to a limit, given that our sample
selection is based on the size of the overnight price move. To evaluate this possibility, we
compute the average absolute overnight price change on days that are subject to a limit
versus days that are not, for the 85 days in our sample. The 66 days with limits had an
average absolute overnight price change of 1.18; the 19 days without limits had an average
of 1.23. Although days with limits averaged a slightly lower overnight price change, a test
of the difference of these means yields a t-statistic of 0.51, which is not statistically
signicant. Thus, there does not appear to be much of a stabilizing effect embodied in the
rst morning price.
Futhermore, the months in our sample contain a total of 1597 trading days for the near
contract. Of these, 1242 are subject to a price limit, and 355 are not. A random draw of 85
observations from this distribution would be expected to yield 66.1 days with limits and
18.9 days without limits. Of the observations in our sample, 66 are subject to a limit, and
19 are not. A binomial test of the proportions of the sample and the population yields a zscore of 0.59 (approximately normal). With little difference in mean overnight price
change and no difference in the distribution of days either subject to or free from limits,
we cannot reject the null hypothesis that our sample is a random draw of days from the
period studied. There does not appear to be systematic grouping of large overnight price
changes in either days with or days without limits, so it is not likely that the reversal is
simply an artifact of our selection process. Thus, neither factor appears to be driving our
results.

3.1. Limit effect versus news effect


It is possible that the closeness to the limit is a proxy for the magnitude of the overnight
price move and that it is, in fact, the overnight price move itself that causes the morning

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

15

reversal of a few ticks. Our NEWS variable captures the overnight price change, which
serves as a measure of information arrival in the market prior to the morning open.
Before the evening session was established, on days when the limit was the previous
settle plus or minus two points, there was a direct correspondence between the size of the
overnight move and the closeness to the limit. However, during the period when the daily
price limits were set at the previous settle plus or minus two points, the limits were usually
expanded to three points for three days following a close at the limit, and, in the last month
of the quarter, limits were removed entirely on the near contract. The January 1980
September 1986 sample has 11 days when the limit is expanded to three points and 17 days
when there is no limit. After September 26 1986, the limit of three points was expanded
to 4.5 points on ve days; two days had no limits. Thus, limits are removed or expanded on
35 days out of the sample of 84. Overall, however, the correlation between CTL and
NEWS is still 0.799.
We perform several tests on NEWS (rather than how close to the limit it pushes the
price) as the cause of the morning reaction. First, we estimate (2) (see table 3 for the
results). In all three samples, the NEWS equation has a worse t than the CTL equation. In
particular, in close proximity to the limit (column 3 in tables 2 and 3), the CTL model is
markedly better; the corrected R2 is 70.1% versus 47.7% with NEWS.
As a second test, we estimate the following model, using both variables:

Table 3. Effect of NEWS on price behavior after the morning open, measured over the rst ve minutes of
trading.
DP b0 b1  S  NEWS b2  S  EVENING
Sample

2s

3s

3.5s

NEWS

0.0628***
( 4.92)
0.0623
(0.97)
0.0480**
(2.01)
85
82
12.09***
22.8%
20.9%

0.0667***
( 4.35)

0.0616***
( 4.06)

0.0760*
(1.66)
30
28
18.90***
40.3%
38.2%

0.0610
(1.17)
18
16
16.51***
50.8%
47.7%

EVENING
CONSTANT
N
d.f.
F
R2
adj. R2

OLS estimates of ve-minute price change regressed on independent variables; t-statistics in parentheses
(H0: bi 0; Ha: bi 6 0).
*** signicant at 0.01 level.
** signicant at 0.05 level.
* signicant at 0.10 level.
DP change in price over rst ve minutes of morning trading
NEWS overnight price change squared
EVENING dummy for existence of evening trading session
S sign of the overnight price change

16

MARCELLE ARAK AND RICHARD E. COOK

Table 4. Role of NEWS versus CTL in explaining price behavior after the morning open, measured over the rst
ve minutes of trading.
DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  NEWS
Sample

2s

3s

3.5s

CTL

0.0338*
( 1.90)
0.0057
(0.27)
0.0300
( 1.35)
0.0495
(0.77)
0.0379
(1.53)
84
79
7.38***
27.2%
23.5%

0.0336
( 1.61)
0.0054
(0.21)
0.0312
( 1.18)

0.0547***
( 3.17)
0.0301
(1.43)
0.0024
( 0.10)

CTL  LMQ
NEWS
EVENING
CONSTANT
N
d.f.
F
R2
adj. R2

0.0472
(0.92)
29
25
7.74***
48.2%
41.9%

0.0291
( 0.54)
17
13
12.25***
73.9%
67.8%

OLS estimates of ve-minute price change regressed on independent variables; t-statistics in parentheses
(H0: bi 0; Ha: bi 6 0).
*** signicant at 0.01 level.
** signicant at 0.05 level.
* signicant at 0.10 level.
DP change in price over rst ve minutes of morning trading
CTL closeness to the limit at the open (see text for full description)
LMQ dummy for last month of quarter
NEWS overnight price change squared
S sign of the overnight price change

DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  NEWS


b4  S  EVENING:

Table 4 shows the results of these regressions. CTL is statistically signicant in two of the
three regressions (and borderline in the third, with a p-value of 12.0%), while NEWS is
not signicant at standard levels. Moreover, when the sample is again restricted to close
proximity to the limit, CTL becomes highly signicant, while the signicance of NEWS
drops dramatically (column 3). LMQ shows the same ambiguity as in table 2, with neither
bLMQ nor bCTL bLMQ statistically different from zero.
As a futher test of the relative contribution of proximity to the limit versus overnight
news, we reestimate (3), pooling all six ve-minute intervals in the rst half hour of
morning trading. The proximity variable CTL is recalculated at the start of each veminute interval. Overnight news remains the same for each interval in the half-hour period,
i.e., the price change from the prior day's last trade to the morning open. In this larger
sample, the correlation coefcient between CTL and NEWS is only 0.042.

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

17

Table 5 presents these results. CTL is highly signicant for all three samples; as in the
rst ve minutes, the limit has a repellent effect. NEWS, on the other hand, is not
signicant at conventional levels in these regressions. In the 2s and 3s samples, LMQ is
not statistically different from zero, indicating that the repellent effect is similar in the last
month of the quarter, when there is no limit. However, in the 3.5s sample, there is a
signicantly smaller repellent effect (at the 10% level) in the last month of the quarter. In
this regression, however, bCTL bLMQ is statistically different from zero, indicating that
the effect of the limit does not completely disappear in that month.
After the introduction of an evening trading session, prices after the morning open tend
to continue in the same direction as overnight by 1.7 ticks, as shown by the signicantly
positive coefcient of 0.053 on EVENING. Taken together with the CTL coefcient, this
implies that price reversal in the morning was mitigated by the establishment of an evening
session. All in all, the evidence again points to the limits having a stabilizing effect.

Table 5. Role of NEWS versus CTL in explaining price behavior after the morning open, measured over all six
ve-minute intervals in the rst half-hour.
DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  NEWS b4  S  EVENING
Sample

2s

3s

3.5s

CTL

0.0367***
( 4.53)
0.0042
( 0.42)
0.0077
(1.24)
0.0531***
(2.70)
0.0058
(0.77)
508
503
11.04***
8.1%
7.3%

0.0452***
( 4.39)
0.0096
(0.73)
0.0078
(1.06)

0.0524***
( 5.31)
0.0222*
(1.73)
0.0106
(1.53)

CTL  LMQ
NEWS
EVENING
CONSTANT
N
d.f.
F
R2
adj. R2

0.0036
(0.23)
178
174
12.12***
17.3%
15.9%

0.0175
( 0.96)
106
102
15.10***
30.8%
28.7%

OLS estimates of ve-minute price change regressed on independent variables; t-statistics in parentheses
(H0: bi 0; Ha: bi 6 0).
*** signicant at 0.01 level.
** signicant at 0.05 level.
* signicant at 0.10 level.
DP change in price over ve-minute intervals, rst half-hour of morning trading
CTL closeness to the limit at start of each ve-minute interval (see text for full description)
LMQ dummy for last month of quarter
NEWS overnight price change squared
EVENING dummy for existence of evening trading session
S sign of the overnight price change

18

MARCELLE ARAK AND RICHARD E. COOK

3.2. Rising versus falling prices


Evidence on asymmetry in stock price movements after signicant positive and negative
news items was found by Brown, Harlow, and Tinic (1988). It is therefore possible that
limits matter more when prices are falling than when they are rising, or vice versa. To test
this possibility, we partition the sample into positive and negative price changes and run
separate regressions (see table 6). An F-test on the sum of squared residuals yields F
values of 0.278 (0.312) using the 2s (3s) samples, indicating that the effect of proximity
to the limit on the behavior of T-bond futures prices is not signicantly different after
positive overnight moves versus negative overnight moves. Note that the 3s sample of
negative price changes contains only 11 observations.
4. Summary and conclusions
This article uses T-bond futures data from 1980 to 1987 to test whether daily price limits
act as magnets (destabilizers). In that market, the daily price limits do not exert a magnet
Table 6. Price behavior after positive and negative overnight price changes, using closeness to the limit. Price
changes are measured over the rst ve minutes of trading after the morning open.
DP b0 b1  S  CTL b2  S  CTL  LMQ b3  S  EVENING
Sample:
Price Change:
CTL
CTL  LMQ
EVENING
CONSTANT
N
d.f.
F
R2
adj. R2

2s

3s

0.0530**
( 2.08)
0.0254
(0.38)
0.0753
(0.81)
0.0100
(0.22)
45
41
2.72
16.6%
10.5%

0.0392**
( 2.27)
0.0073
(0.05)
0.0376
(0.34)
0.0684
(1.22)
39
35
1.99
14.6%
7.2%

0.0542
( 1.69)
0.0405
(0.46)

0.0333
( 1.52)
0.0175
(0.07)

0.0026
( 0.03)
18
15
1.78
19.2%
8.4%

0.1278
(1.10)
11
8
1.23
23.5%
4.3%

OLS estimates of ve-minute price change regressed on independent variables; t-statistics in parentheses
(H0: bi 0; Ha: bi 6 0).
*** signicant at 0.01 level.
** signicant at 0.05 level.
* signicant at 0.10 level.
DP change in price over rst ve minutes of morning trading
CTL closeness to the limit (see text for full description)
LMQ dummy for last month of quarter
EVENING dummy for existence of evening trading session
S sign of the overnight price change

DO DAILY PRICE LIMITS ACT AS MAGNETS? THE CASE OF TREASURY BOND FUTURES

19

effect on price behavior. In fact, they appear to exert a small repellent (stabilizing)
effect.
Our tests separate the effect of proximity to the limit from size of the overnight price
change. We nd that the reversal is better explained as being related to proximity to the
daily price limit per se, rather than to the overnight price change. This is consistent with
the hypothesis that limits act as a stabilizing force, tending to calm the market.

Acknowledgments
The authors would like to thank Pam Wolfe for many hours of expert research assistance
and express appreciation to Fischer Black, Robert Daigler, Dean Leistikow, K.C. Ma, and
Naci Mocan for helpful comments. In addition, Robert Eisenbeis (the editor) and two
anonymous referees at JFSR made many excellent suggestions. Also, we are grateful for a
grant from the Columbia Center for the Study of Futures Markets. Earlier drafts of this
article were presented at the 1991 meeting of the Southern Finance Association and the
1992 Financial Management Association meetings.

Notes
1. The rationality of daily price limits has been discussed by Brennan (1986) and by Ackert and Hunter (1989),
although neither addressed the effects of limits on price movements.
2. See Shleifer and Summers (1990) for a good discussion of noise traders in nancial markets.
3. Several studies nd evidence that markets are more active and more volatile before and after trading halts.
Gerety and Mulherin (1990) examine NYSE data from the 19331988 period and nd that trading activity at
the close is related to expected overnight volatility, while trading at the open reects unexpected overnight
volatility. Ma, Peterson, and Sears (1991) look at bid-offer spreads in four futures markets and conclude that
they are wider in the rst and last half hours of trading.
4. Note that the multiplication of independent variables by S in these equations gives all independent variables
the same sign as the overnight price change. Also, this formulation of the model imposes symmetry on the
response to positive and negative news. We separate positive and negative news later in the article.
5. The two-standard-deviation cutoff represents a tradeoff between degrees of freedom and noise in the data.
Since the choice is arbitrary, we use more restrictive selection rules as well.
6. The raw data for 11 months in the 19801987 sample period were not available from Tick Data.
7. One observation was lost from the rst ve-minute sample because the opening price was at the limit.
8. A trading halt during the day session, caused by hitting a limit, shuts the market only until 5:20 p.m., rather
than until the next morning. Note that a halt during the evening session can remain in effect until 5:20 p.m.
the next day, when the new trading day begins. However, we do not investigate price behavior at the open of
the evening session.
9. The EVENING dummy does not provide sufcient variation to enable us to use it interactively.
10. This is in keeping with the nonlinear treatment of CTL.
11. In the 1597 trading days sampled, only three overnight changes were two points or larger.
12. According to the CBOT rules, limits on the T-bond futures contract are expanded as follows: If three or
more contracts within a contract year close at the limit (or all contracts in a given year if there are less than
three open contracts), the limits are expanded to 150% of the normal limit for the following three days.

20

MARCELLE ARAK AND RICHARD E. COOK

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