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Are price limits on futures markets that cool? Evidence from the Brazilian Mercantile and Futures Exchange

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Disciplines
  • Economics

Abstract

No 630 ISSN 0104-8910 Are price limits on futures markets that cool? Evidence from the Brazilian Mercantile and Futures Exchange Marcelo Fernandes, Marco Aure´lio dos Santos Rocha Novembro de 2006 Os artigos publicados são de inteira responsabilidade de seus autores. As opiniões neles emitidas não exprimem, necessariamente, o ponto de vista da Fundação Getulio Vargas. Are price limits on futures markets that cool? Evidence from the Brazilian Mercantile and Futures Exchange Marcelo Fernandes Queen Mary, University of London Mile End, London, E1 4NS, UK Tel: +44 20 7882 5082 E-mail: [email protected] Marco Aure´lio dos Santos Rocha University of Illinois at Urbana-Champaign E-mail: [email protected] Abstract: This paper investigates the impact of price limits on the Brazilian futures markets using high frequency data. The aim is to identify whether there is a cool-off or a magnet effect. For that purpose, we examine a tick-by-tick data set that includes all contracts on the Sa˜o Paulo stock index futures traded on the Brazilian Mercantile and Futures Exchange from January 1997 to December 1999. The results indicate that the conditional mean features a floor cool-off effect, whereas the conditional variance significantly increases as the price approaches the upper limit. We then build a trading strategy that accounts for the cool-off effect in the conditional mean so as to demonstrate that the latter has not only statistical, but also economic significance. The in-sample Sharpe ratio indeed is way superior to the buy-and-hold benchmarks we consider, whereas out-of-sample results evince similar performances. JEL Classification: C22, G12, G15, G18. Keywords: cool-off effect, futures markets, magnet effect, price limits, transactions data. Acknowledgements: We are grateful to Verdi Rosa and Cicero Vieira at BM&F for providing the data as well as for helpful discussions. We are also indebted to two anonymous referees, Marco Bonomo, Walter Nov

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