Please Note: This seminar will be given in person.
Actuarial Science and Financial Mathematics seminar series
Room: M3 3127
The Dark Side of Circuit Breakers
Market-wide trading halts, also called circuit breakers, have been widely adopted as part of the stock market architecture, in the hope of stabilizing the market during dramatic price declines. We develop an intertemporal equilibrium model to examine how circuit breakers impact market behavior and welfare. We show that a circuit breaker tends to lower the overall level of the stock price and significantly alters its dynamics. In particular, as the price approaches the circuit breaker, its volatility rises drastically, accelerating the chance of triggering the circuit breaker -- the so-called ``magnet effect''; in addition, returns exhibit increasing negative skewness and positive drift, while trading activity spikes up. Our empirical analysis finds supportive evidence for the model's predictions. Moreover, we show that a circuit breaker can affect the overall welfare either negatively or positively, depending on the relative significance of investors' trading motives for risk sharing vs. irrational speculation.