The Dark Side of Circuit Breakers |
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| Authors: | HUI CHEN ANTON PETUKHOV JIANG WANG HAO XING |
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| Institution: | 1. Correspondence: Jiang Wang, MIT Sloan School of Management, E62-614, 100 Main Street, Cambridge, MA 02142, USA;2. e-mail: wangj@mit.edu.;3. Hui Chen is with Sloan School of Management at MIT and NBER. Anton Petukhov is with Citadel. Jiang Wang is with Sloan School of Management at MIT, CAFR, and NBER. Hao Xing is with Questrom School of Business at Boston University. We are grateful to Philip Bond (the Editor) for insightful suggestions, the Associate Editor, and two anonymous referees for valuable comments. We thank Daniel Andrei;4. Doug Diamond;5. Jennifer Huang;6. Leonid Kogan;7. Pete Kyle;8. Hong Liu;9. Lubos Pastor;10. Steve Ross;11. Liyan Yang;12. and seminar participants at Boston University, INSEAD, MIT, Peking University, PBCSF, University of Chicago, NBER Asset Pricing meeting, Minnesota Asset Pricing Conference, NYU Shanghai Volatility Institute Conference, Hanqing Summer Finance Workshop, CICF, and WFA for comments. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose. |
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| Abstract: | Market-wide circuit breakers are trading halts aimed at stabilizing the market during dramatic price declines. Using an intertemporal equilibrium model, we show that a circuit breaker significantly alters market dynamics and affects investor welfare. As the market approaches the circuit breaker, price volatility rises drastically, accelerating the chance of triggering the circuit breaker—the so-called “magnet effect,” returns exhibit increasing negative skewness, and trading activity spikes up. Our empirical analysis supports the model's predictions. Circuit breakers can affect overall welfare negatively or positively, depending on the relative significance of investors' trading motives for risk sharing versus irrational speculation. |
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