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Applied Financial Economics Letters


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Are limit hits industry-specific?
To cite this Article: , 'Are limit hits industry-specific?', Applied Financial Economics
Letters, 3:2, 115 - 119
xxxx:journal To link to this article: DOI: 10.1080/17446540600905112
URL: http://dx.doi.org/10.1080/17446540600905112

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Applied Financial Economics Letters, 2007, 3, 115–119
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Are limit hits industry-specific?


Haitham Nobanee
Department of Banking and Finance, The Hashemite University,
PO Box 330221, Zarqa, 13133, Jordan
E-mail: nobanee@yahoo.com

This study aims to examine the industry effect of limit hits of Tokyo Stock
Exchange. The results show evidence of industry effect where information
technology companies have the highest limit hits per company and utilities
companies have the lowest limit hits per company. High-limit hit
occurrences for different industries are associated with high volatility
and low-limit hit occurrences are associated with low volatility.

I. Introduction Tokyo Stock Exchange (and other stocks exchanges)


applies the same price limits rules for all industries.
Price limits are artificial boundaries that restrict daily However, different industries may have different
price changes of a stock to a pre-specified range. The volatility or risk levels. Maybe one should argue
commonly cited advantages of inducing price limits that price limits for low-risk stocks should be tighter
include preventing extreme price movements1, and wider for high-risk stocks. If the result of this
facilitating price discovery, reducing the potential study shows an important industry effect of limit hits,
default risk2 and counter overreaction (Cho et al., imposing different price limit rules for different
2003). On the other hand, several studies address industries could help in minimizing the disadvantages
problems of price limits in achieving these goals. of applying price limit rules. In this way, the results of
Problems of price limits include reducing market this study will be beneficial for the policy makers and
liquidity, delaying price discovery3 and weakening regulators of stock exchanges. The industry effect of
market efficiency.4 Instead of reducing volatility, price price limit hits has not been examined before.
limits may cause volatility to spread over longer
periods of time.5
Some studies applied an event-study methodology
to test for the effectiveness of price limits in curbing
undesired fluctuations of stock prices [such as the
II. Data and Methodology
study of Min-Tsung and Yeong-Jia (2006) published
in Volume 2 in this Journal]. However, event-study
Data
methodology could be subject to some limitations.
For example, comparing the volatility before and The data in this study contains 1467 companies.
after the limit hit are subject to problems of The data are downloaded from the Datastream. Base
interpretation because volatility is well known to be prices are adjusted for cash dividends, corporate
serially dependent. actions such as stock splits and stock dividends. Tick
The aim of this study is to examine whether the size rules described on Table 1 also considered when
occurrences of limit hits vary across industries. identifying limit hit occurrences.
1
See Brennan (1986), Ma et al. (1989a, b) and Kim and Rhee (1997).
2
See Brennan (1986) and Ma et al. (1989b).
3
See Fama (1989), Lehmann (1989), Ma et al. (1989a, b) and Kim and Rhee (1997).
4
See Fama (1989) and Lehmann (1989).
5
See Kim and Rhee (1997), Lehmann (1989) and Fama (1989).
Applied Financial Economics Letters ISSN 1744–6546 print/ISSN 1744–6554 online ß 2007 Taylor & Francis 115
http://www.tandf.co.uk/journals
DOI: 10.1080/17446540600905112
116 H. Nobanee
Table 1. Minimum price fluctuations or tick size rules
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Price per share (yen) Before April 1998 April 1998 to July 2000 July 2000 to present
Up to 1000 1 1 1
Up to 2000 10 1 1
Up to 3000 10 5 5
Up to 10 000 10 10 10
Up to 30 000 100 10 10
Up to 50 000 100 50 50
Up to 100 000 100 100 100
Up to 1 million 100 1000 1000
Up to 20 million 100 10 000 10 000
Up to 30 million 100 10 000 50 000
Up to 30 million 100 10 000 100 000
The table reports minimum price fluctuations or tick size rules applied in the Tokyo Stock Exchange. Tick size
rules were subject to two revisions took place in April 1998 and July 2000.

Companies analysed in this study are grouped impose the nonnegativity constraints on parameters.
according to their industries. FTSE industrial classi- Hence, to test for the industry effect, an E-GARCH-
fication Level Three, which has ten sectors, is M model with the following form is used:
selected. These ten sectors includes: resources, basic
X
10
industries, general industries, cyclical consumer Lit ¼ it dit þ it it2 þ "it ð1Þ
goods, noncyclical consumer goods, cyclical services, t¼1
noncyclical services, utilities, financials and informa- 2 3
tion technology.6 rffiffiffi
   2  "t1 6 "t1 27
To prevent wild volatility, the Tokyo Stock log it2 ¼  þ #  log it1 þ   pffiffiffiffiffi þ 4qffiffiffiffiffiffiffiffiffiffi  5
2
it 2 
Exchange sets several market mechanisms such as it1
daily price limits, and tick size rules. Table 1 presents
ð2Þ
the new and old tick size rules, while daily price limits
are set out in the Table 2 below. where Lt is the limit hits in time t, dt is a dummy
variable where d1 equals 1 for resources and zero
otherwise, d2 equals 1 for Basic Industries and zero
Methodology otherwise, and so on. The test concerns the hypoth-
Industry effect of limit hits analysed in this study esis that the industries coefficients should be equal,
using EGARCH, which has proposed by Nelson such that 1 ¼ 2 ¼    ¼ 10. If resource’s limit hits or
(1991). EGARCH is applied in this study in order to basic industry’s limit hits are significantly different
test the industry effect of limit hits for the following than other industries, then 1 or 2 should be
reasons. First, it allows for the information asym- significant.
metry, the leverage effect in the model captures the
asymmetric effect of the good and bad news.
In Tokyo Stock Exchange, good news is more likely
to reveal faster in spot prices than bad news due to III. Empirical Results
the restricted short selling (Chung et al., 1994).
Second, unlike GARCH specification, the Occurrences of limit hits are sorted by industry.
EGARCH model, specified in logarithms, does not Table 3 reports the occurrences of total, upper and
6
Recourses includes ‘Mining’ and ‘Oil & Gas’. Basic industries include ‘Chemicals’, ‘Construction & Building Materials’,
‘Forestry & Papers’ and ‘Steel & Other Metals’. General industries include ‘Aerospace & Defence’, ‘Diversified Industries’,
‘Electronic & Electrical Equipment’ and ‘Engineering Machinery’. Cyclical consumer goods consists of ‘Automobiles & Parts’
and ‘Household Goods & Textiles’. Noncyclical consumer goods includes ‘Beverages’, Food Producers & Processors’,
‘Health’, ‘Personal Care & Household Products’, ‘Pharmaceuticals & Biotechnology’ and ‘Tobacco’. Cyclical services includes
‘General Retailers’, ‘Leisure’, ‘Entertainment & Hotels’, ‘Media & Photography’, ‘Support Services’, ‘Transport’, ‘Food &
Drug Retailers’ and ‘Telecommunication Services’. Utilities sector consists of ‘Electricity’, ‘Gas Distribution’ and ‘Water’.
Financials includes ‘Banks’, ‘Insurance’, ‘Life Insurance’, ‘Investment Companies’, ‘Real Estate’, ‘Speciality & Other Finance’
and ‘Investment Entities’. Finally, information technology includes ‘Information Technology Hardware’ and ‘Software &
Computer Services’ (for more information about the FTSE industrial classification please see FTSE International Limited
and the JSE Securities Exchange South Africa, 2002).
Are limit hits industry-specific? 117
Table 2. Daily price limits for different stock price levels before and after July 2000 revision
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Previous day’s closing price (yen) Price limits (before July 2000) Price limits (after July 2000)
Less than 100 30 30
Less than 200 50 50
Less than 500 80 80
Less than 1000 100 100
Less than 1500 200 200
Less than 2000 300 300
Less than 3000 400 400
Less than 5000 500 500
Less than 10 000 1000 1000
Less than 20 000 2000 2000
Less than 30 000 2000 3000
Less than 50 000 3000 4000
Less than 70 000 5000 5000
Less than 100 000 5000 10 000
Less than 150 000 50 000 20 000
Less than 200 000 50 000 30 000
Less than 300 000 80 000 40 000
Less than 500 000 80 000 50 000
Less than 1 million 100 000 100 000
Less than 1.5 million 200 000 200 000
Less than 2 million 300 000 300 000
Less than 3 million 400 000 400 000
Less than 5 million 500 000 500 000
Less than 10 million 1 million 1 million
Less than 15 million 2 million 2 million
Less than 20 million 2 million 3 million
Less than 30 million 2 million 4 million
Less than 50 million 2 million 5 million
Greater than or equal 50 million 2 million 10 million
The table reports daily price limits applied in the Tokyo Stock Exchange for different stock price levels before
and after July 2000 revision.

Table 3. Limit hits occurrences by industry and SD of stock prices by industry


Limit hits Limit hits per company

Number of
Industry companies All Upper Lower All Upper Lower SD
Resources 27 166 107 59 6 4 2 3.98
Basic industries 383 1817 1272 545 5 3 2 3.77
General industries 350 2098 1430 668 6 4 2 5.06
Cyclical consumer goods 177 1110 709 401 6 4 2 4.11
Noncyclical consumer goods 129 643 454 189 5 4 1 3.86
Cyclical services 162 885 552 333 5 3 2 6.66
Noncyclical services 21 156 85 71 7 4 3 6.73
Utilities 18 18 18 0 1 1 0 3.41
Financials 171 858 482 376 5 3 2 4.65
Information technology 29 299 204 95 10 7 3 16.05
Total 1467 8050 5313 2737 6 4 2
The table reports the occurrences of limit hits for stocks listed in the Tokyo Stock Exchange during the period 1990 to 2002.
We report the number of price limit hits by industry. Upper and lower indicates the two sub samples of upper-limit hits and
lower-limit hits. Limit hits per company are the number of limit hits occurrences for each industry divided by the number of
companies in each industry.
118 H. Nobanee
Table 4. EGARCH-M results of limit hits across industries
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Industry Coefficients SE Z-statistics


Mean equation
Resources 0.001 0.001 0.949
Basic industries 0.001 0.001 1.203
General industries 0.001 0.001 1.599
Cyclical consumer goods 0.001 0.001 1.705
Noncyclical consumer goods 0.001 0.001 1.203
Cyclical services 0.001 0.001 1.414
Noncyclical services 0.001 0.001 1.665
Utilities 0.000 0.001 0.211
Financials 0.001 0.001 0.871
Information technology 0.002 0.001 2.754*
Variance equation
C 0.165 0.032 5.169*
ARCH 0.031 0.007 4.355*
GARCH 0.048 0.006 8.267*
LEVARIGE 0.988 0.003 394.279*
The table reports EGARCH-M results of limit hits across industries.
*Coefficients are significant at 0.01 level.

lower limit hits by industry. Table 3 below also Imposing different price limit rules for different
reports the level of risk measured by SD of stock industries could help in minimizing the disadvantages
prices for each industry. The results show that the of applying price limit rules, namely prevention of
information technology sector has higher number price discovery. The industry effect of limit hits has
of all limit hits per company and utilities sector has not been examined before. The results show evidence
the lower number of all limit hits per company. of industry effect where information technology
This result for information technology and utilities companies have the highest limit hits per companies
indicates that an industry effect on limit hits might and utilities companies have the lowest limit hits per
exist. The results also show that information company. High-limit hit occurrences for different
companies have the largest SD while utilities compa- industries are associated with high volatility and
nies have the lowest SD. These results are quite low-limit hit occurrences are associated with low
consistent with the limit hits per company. This volatility.
indicates that high-limit hit occurrences are asso-
ciated with high volatility (or high level of risk) and
low-limit hit occurrences are associated with low
volatility. References
The EGARH-M results of limit hits also show Brennan, M. J. (1986) A theory of price limits in the futures
significant differences for information technology. markets, Journal of Financial Economics, 16, 213–33.
The EGARH-M results shown on Table 4 strongly Cho, D. D., George, J. R., Tiao, C. and Tsay, R. (2003)
support the industry effect of limit hits on Japan. The magnet effect of price limits: evidence from high
frequency data on Taiwan stock exchange, Journal of
Empirical Finance, 10, 133–68.
Chung, Y. P., Kang, J. and Rhee, G. (1994) The lead-lag
relationship between the stock market and the index
future market in Japan, Working Paper, University of
IV. Conclusion Rhode Island.
Fama, E. (1989) Perspectives on October (1987), or, what
This study discusses the industry effect of limit hits. did we learn from the crash? in Black Monday and the
Tokyo Stock Exchange applies the same price limits Future of Financial Markets (Eds) R.W. Kampuis,
rules for all industries. However, different industries R.C. Kormendi and J.W.H. Watson, Homewood:
Dow-Jones-Irwin, pp. 71–82.
may have different volatility or risk levels. Maybe one Kim, K. A. and Rhee, S. G. (1997) Price limit performance:
should argue that price limits for low-risk stocks evidence from the Tokyo stock exchange, Journal of
should be tighter and wider for high-risk stocks. Finance, 52, 885–901.
Are limit hits industry-specific? 119
Lehmann, B. (1989) Commentary: volatility, price resolu- treasury bond futures market, Journal of Futures
tion, and the effectiveness of price limits, Journal of Markets, 9, 321–35.
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Financial Services Research, 3, 205–9. Min-Tsung, C. and Yeong-Jia, G. (2006) The application of
Ma, C. K., Roa, R. P. and Sears, R. S. (1989a) an intervention model to the taiwan stock exchange
Volatility, price resolution, and the effectiveness of price limits policy, Applied Financial Economics
price limits, Journal of Financial Services Research, 3, Letters, 2, 31–6.
67–101. Nelson, D. B. (1991) Conditional heteroskedasticity in
Ma, C. K., Roa, R. P. and Sears, R. S. (1989b) asset returns: a new approach, Econometrica, 59,
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