Magnet Effect, Order Submission Behavior and Liquidity Supply
Author
Abstract
Though the aim of setting price limit is to prevent excessive price variations, its role as circuit breakers is often doubted. Among the adverse effects of price limits, magnet effect continues to attract a lot of attention. It refers to the phenomenon that the price limit acts as a magnet for stock prices. Most previous studies focus on whether the magnet effect exists, yet the causes are not well explored. Applying order- and trade-level data, this paper examines the magnet effect in the Taiwan Stock Market. Evidence shows, first, that the price limit acts as a magnet and further pulls the price even closer to the limit. Although the price pressure before hitting the limit is mainly caused by the order imbalances by individual investors, the precious stock returns could change the relative influences of institutional and individual trading activities, and, thus, the strength of the magnet effect. Second, price limit affects investors' order submission behaviors. When approaching the price limit, order submission behaviors, especially of individuals and security dealers, become more aggressive by switching from nonmarketable to marketable limit orders and cancelling more frequently nonmarketable limit orders. These changes in investors' submission strategy reduce stock liquidity supply and raise volatility, leading to the so-called magnet effect.
Key Words
Magnet Effect, Order Imbalance, Price Limit, Liquidity Supply
