NSE: Moderating Volatility, Market Manipulation via Price Limit

10 Apr 2013

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NSE  DG, Oscar Onyema

The recent introduction of a 10 per cent up and down price limit by the Nigerian Stock Exchange (NSE) will ensure market liquidity, moderate excessive volatility, mitigate panic behaviour, and/or minimise price manipulation. But investor education and the capacity of stockbrokers to determine fair prices and manage their exposures need to be established, writes Eromosele Abiodun

Recently the Nigerian Stock Exchange (NSE) increased the daily price limit (up or down) on all listed equities from five per cent to 10 per cent. Before now, only  52 stocks that were  in the market making basket experienced a daily price swing of 10 per cent, while others outside the basket were allowed only  five per cent movement.

Executive Director, Business Development, NSE, Haruna Jalo-Waziri, explained that the decision to raise the price limit was informed by the feedback received in the six months of the market-making programme. Meanwhile, while the NSE did not give many details as to why it raised the price limit, the decision has elicited arguments from stakeholders in the market. However, the fact that most stock exchanges around the world impose daily price limits is not disputable, but the rationale behind price limits varies. For example, the two stock markets in China, the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) with 1,060 listed stocks and a total market capitalisation of about $500 billion currently impose a 10 per cent daily price limit.

For most exchanges, the approach is to moderate excessive volatility, mitigate panic behaviour, and/or minimise price manipulation. But some analysts have criticised price limits.  This is because they believe price limits impede market efficiency, while showing no evidence of achieving their intended objectives. Some analysts believe price limits are costly when they obstruct rational price movements.

Analysts believe observable events, such as volatility spillovers and consecutive price limit hits, associated to improper price limit imposition can be predicted using proxies of informed and uninformed trading, changes in order imbalance, number of trades hitting price limit, fraction of the trading day affected by limit hit and security characteristics such as size, growth and idiosyncratic risk.

Flexible Price Limit
"I like a flexible price limit system based on the predicted likelihood of improper price limit imposition. I suggest that if exchange-officials decide on relaxing or continue imposing price limits for a trading day based on predicted probability of volatility spillover and consecutive hit then price limit rules could become effective, " said a trader who did not want his name mentioned.
Price limits, he stated, moderate transitory volatility and mitigates abnormal trading activity.

“For poor performing stocks, a tighter price limit also appears helpful in moderating volatility and not hurtful. Also, there are some evidence that price limits can facilitate market recovery following crashes,” he said.

On his part, Executive Director, Dunn Loren Merrifield Securities Limited, Mr. Idowu Ogedengbe, said the NSE might have decided to raise price limit to improve market liquidity.

According to him, “The recent introduction of a 10 per cent limit up-down price limit on all equities traded on the Nigerian bourse was done against the backdrop of the need to reduce market volatility while at the same time enhancing market liquidity.

“On the New York Stock Exchange (NYSE) for example, circuit breakers were put in place after "Black Monday" when the Dow Jones Industrial Average (DJIA) bizarrely dropped almost 1,000 points in 20 minutes, then snapped back on extraordinary volume.

“Currently, at the start of each quarter, the NYSE sets three circuit breaker levels at levels of 10 per cent, 20 per cent, and 30 per cent of the average closing price of the DJIA for the month preceding the start of the quarter. “

Ogedengbe added that the use of trading curb or circuit breaker is a global practice adopted by major stock market regulators adding that such limits are usually placed on the index instead of individual stocks as it is the case in Nigeria.

Circuit Breaker in India
“In India, where circuit breaker was first introduced in 1992, both the index and price of quoted companies have limits set on them.  However, it is instructive to note that trading in the market is usually halted, at the initial stage when such limits are reached. However, in Nigeria, trading continues even when minimum or maximum prices on stocks are attained, leading to either the accumulation of net offers or net bid orders.

“Although the market makers (MM) are expected to provide some intervention in this regard, there are constraints being faced by the MM in terms of their capacity to assume such risks. This recent move by the NSE would facilitate a level playing field across the market for all operators and also promote a more transparent market where equal rules apply to all stocks quoted on the NSE,” he said.
Equity Analyst at Agusto & Co, Mr. Abisodun Soetan, said the price limit increase would help sustain investor confidence.

He said: “As investor confidence gradually returns to our stock market, the increase in daily price limit from five per cent to 10 per cent has come at a good time. The NSE continues to push for better disclosure and transparency, and the introduction of market makers should drive efficiency going forward. However, price limit systems are used to stabilise stock prices, so the relaxation of the limit will likely mean greater volatility in our market.”

Investors Education
He therefore warned on the need to proceed with caution stressing that Investor education and the capacity of stock brokers to determine fair prices and manage their exposures needs to be in place.

“Otherwise sentiment can take over, leading to irrational price fluctuations and loss in investor confidence, “he added.
He further stated that most exchanges around the world have measures in place to protect investors from irrational price fluctuations.
“For the more automated exchanges like the NYSE in the US and FTSE in London, there is a lot of high frequency trading and circuit breakers are used to guard against mini market crashes or "flash crashes". Emerging markets however, tend to use price limit systems. These are less complicated than circuit breakers.

“Studies have shown that restrictive price limit systems hinder the markets ability to accurately price stock; and if investors are less confident about prices, liquidity will suffer!  These days the tendency around the world is to have less restrictive limits, and the NSE's 10 per cent limit is not out of place when compared to Asian and South American exchanges. In fact, the most efficient African exchange, the Johannesburg Stock Exchange (JSE), has no limit in place at all,” he said.

Tags: Nigeria, Featured, Business, NSE, Moderating Volatility, Market Manipulation, Price Limit

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