Effects Of Price Limits On Price Discovery Process In China's Stock Market And Trading Strategy Analysis

In the capital market, the price limits scheme is the most common and often-used price stability mechanism, the invention of it is mainly for inhibiting excessive volatility of the market so as to ensure the normal operation of the stock market. However, the price limits scheme is a man-made policy system, there is great possibility that it will break the normal operation of the stock market and interfere with the stock price movements. Therefore so far, there are still a lot of different opinions about the practical application and function of the price limits scheme in the academic world. This paper mainly studies on the effects of the price limits system on the stock price discovery process in China's stock market. In addition, we also put forward practical trading strategy design for individual investors based on some empirical findings.Our paper has screened all the daily trading data of the component stocks in the Shanghai and Shenzhen 300 index from 2000 to 2013. By introducing the control group and event window as the empirical study method, we have found that in the subsequent trading days those stocks which experienced the price limits hitting would show a significant outperformance than those stocks which haven't hit the price limitation but still performed well enough to get close to the price limitation. At the same time, we have further proved the inefficiency of China's A-share market and the investor sentiment has significant impact on the stock price movement in following trading days. Through a series of empirical research and testing, we find that the price limits mechanism will hinder the price discovery process in the stock market to a certain degree.Based on the above, this paper put forward a trading strategy with strong operability and effectiveness. This trading strategy is not only considerable on yields, but also with more realistic significance as we take the research factor like investor sentiment and behavior into consideration. On the one hand, our paper provides individual investor a new way of enlightment and investment. What's more, it also gives regulators and policy makers a new understanding about the effect and function of the price limits mechanism. On the basis of this, it could better help them to cope with all potential changes and challenges faced by China's capital market.