Description:
Exchanges commonly use circuit breakers as a market-stability tool to mitigate excess volatility and avoid erroneous or highly uninformed trading. Technological advancements have allowed regulators to experiment with innovative circuit-breaker design mechanisms. We evaluate the special quotes (SQs) rule in Japan and the limit up-limit down (LULD) rule in the U.S. to identify the effectiveness of limit pricing structure, cooling off period, and other important design characteristics. We find that wider price bands, slower reference price adjustments, and liquidity demand features foster greater market quality. The benefits of these characteristics include faster speed at which prices incorporate fundamental information, the absence of the magnet effect, reduced volatility spillover, and fewer unnecessary trading halts and delays. Our results are robust to typical market conditions as well as times of extreme market volatility