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Journal of Financial Econometrics Advance Access originally published online on February 19, 2007
Journal of Financial Econometrics 2007 5(2):219-242; doi:10.1093/jjfinec/nbm001
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Copyright © The Author 2007. Published by Oxford University Press.

Special Issue on Econometrics of Financial and Insurance Risks

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

Marcelo Fernandes
     Queen Mary, University of London

Marco Aurélio Dos Santos Rocha
     University of Illinois at Urbana-Champaign

Address correspondence to Marcelo Fernandes, Queen Mary, University of London, E1 4NS, London, UK, or e-mail: m.fernandes{at}qmul.ac.uk


  Abstract

This article investigates the impact of price limits on the Brazilian futures markets using high frequency data. The aim is to identify whether there is an ex ante cool-off or magnet effect. For that purpose, we examine a tick-by-tick data set that includes all contracts on the São Paulo stock index futures traded on the Brazilian Mercantile and Futures Exchange (BM&F) from January 1997 to December 1999. The results indicate that, altogether, there is a dominant cool-off effect in play and that the latter is much stronger for the floor rather than ceiling price. This explains why we observe more hits to the ceiling rather than to the floor in our sample despite the fact it covers one of the most turbulent periods for emerging markets. 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 Sharpe ratio is indeed way superior to the buy-and-hold benchmarks we consider.

KEYWORDS: cool-off effect, futures markets, magnet effect, price limits, transactions data

We are grateful to Verdi Rosa and Cicero Vieira at the BM&F for providing the data as well as for helpful discussions. We are also indebted to two anonymous referees, Marco Bonomo, Andrea Carriero, Emmanuel Guerre, Stepana Lazarova, Walter Novaes, and seminar participants at ECARES, Universidade Nova de Lisboa, Warwick Business School, Queen Mary, International Conference on Finance in Copenhagen, and EC2 Conference on "Econometrics of Financial and Insurance Risk" in Istanbul for their valuable comments and suggestions. We thank the financial support from CNPq and from the Central Bank of Brazil, respectively. The usual disclaimer applies.

Received March 1, 2006; revised November 27, 2006; accepted January 11, 2007


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