The effectiveness of coordinating price limits across futures and spot markets

✍ Scribed by Pin-Huang Chou; Mei-Chen Lin; Min-Teh Yu

• Publisher: John Wiley and Sons
• Year: 2003
• Tongue: English
• Weight: 170 KB
• Volume: 23
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.10076

✦ Synopsis

Abstract

We extend the work of Brennan (1986) to investigate whether the imposition
of spot price limits can further reduce the default risk and lower the effective margin requirement for a futures
contract that is already under price limits. Our results show that spot price limits do indeed further reduce the
default risk and margin requirement effectively. In addition, the more precise the information is that comes from
the spot market, the more the spot price limit rule constrains the information available to the losing party. The
default probability, contract costs, and margin requirements are then lowered to a greater degree. Furthermore,
for a given margin, both spot price limits and futures price limits can partially substitute for each other in
ensuring contract performance. The common practice of imposing equal price limits on both the spot and futures
markets, though not coinciding with the efficient contract design, has a lower contract cost and margin
requirement than that without imposing spot price limits. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark
23:577–602, 2003