Widening Price Limit Effects on Volatility : Using Portfolio Return and EGARCH Model

This study examines how the relaxation of daily price limits affected volatility in the Korean stock market. Previous studies failed to conclusively determine the effect of relaxed price limits on volatility, with some concluding that volatility actually increased, while others empirically demonstrated the opposite. Such inconsistent results were due to the lack of a control group in those studies. In order to avoid the same pitfalls, we compared two markets: the KOSPI and KOSDAQ indices. Over the years, both markets experienced gradual relaxation of their respective daily price limits. This study focuses on four separate events where the price limit of one market was relaxed compared to before, while its counterpart maintained the status quo. Moreover, we employed a single criteria when selecting stocks for portfolios in each market, with regards to company size and book-to-market ratio. It is expected that such precautions will improve homogeneity between the portfolios compared, thus excluding factors other than the relaxation policy that might affect stock price volatility. Through such efforts, we reached the conclusion that the net effect of recent relaxations in price limits was to decrease the volatility of stock prices.