CAN PRICE LIMITS REDUCE STOCK PRICE VOLATILITY?EMPIRICAL EVIDENCE FROM AMMAN STOCK EXCHANGE

Following the October 1987 stock market collapse, interest in the effect and impact of circuit breakers on market volatility has grown among practitioners, academics and regulators. Circuit breakers are market tools designed to control prices from falling in times of panic selling by providing a short cooling-down period to prevent non- rational overreaction and avoid stock market crashes. They have been recommended as a mechanism to stabilize trading activities and to reduce stock market volatility. Hence, many stock markets have adopted circuit breakers to temporarily control trading after large and rapid price changes. Although many research papers investigate the issue of circuit breakers, the critical impact of circuit breakers on the operation of markets is still uncertain whether in academia or industry. Studies that support the implementation of circuit breakers point out their importance in managing settlement risk and reducing volatility by giving traders some time to think rationally during times of panic trading. On the other side, opponents argue that circuit breakers increase volatility and interfere with trading, liquidity and price discovery. The purpose of this paper is to give an empirical examination of the effect of one type of circuit breaker rules - price limits - on the daily stock return volatility in Amman Stock Exchange(ASE). Whether price limits reduce or increase the stock price volatility is a question that has long attracted research interest. By comparing the volatility level in the ASE market before and after the price limit hit days, the study will show the effectiveness of adopting the price limit rule. This study will investigate the behavior of stock price volatility around the price limit hit for a sample of 25 Securities listed in Amman Stock Exchange in both the first and second markets representing different sectors for the period between January 1, 2002 and December 31, 2006. Overall, the study arrives at the result of price limits effectively reducing stock market volatility by acting as a market stabilizer and providing a time out for investors to think rationally with less emotion during times of panic trading.