The Effects of Price Limit on Tehran Stock Exchange

Some stock exchanges in emerging markets impose price limit on stock prices to prevent over-reaction to financial disasters. Price limit is advocated as a mean to help investors cool down and decide rationally. Officials believe that price limit prevents financial crises; however many researches have shown that price limit backfires Volatility spillover, Delay Price-discovery, Overreaction, and Trading interference. Tehran Stock Exchange (TSE) has limited traders to deal stock in a predetermined interval, usually as a percentage of the last closing stock price. Thus in a trading session, stock price can only change in a limited percent of last closing price. In comparison to other stock exchanges, TSE has used one of the narrowest limits. Price limits during the last 10 years have been varied from 1 percent to up to 5 percent respectively. This study revealed that price limit in TSE causes “Volatility spillover” and “Delay price-discovery”. There was no significant support for two other negative effects (Overreaction, Trading interference). Although price limit prevents stock volatility in short term, it backfires volatility in long term. Additionally, price limit generates an ascending or descending price trend to reach equilibrium level for securities, and thus delays price discovery.