Liquid and Efficient : How Widening Price Limits Affect Stock Market Performance

Price limits are commonly adopted regulatory restrictions in financial markets, yet their impacts on market performance remain controversial. Exploiting a price-limit widening policy in China, we investigate the impacts of price limits using the difference-in-differences methodology. Stocks are more liquid following the price-limit widening but the liquidity improvement is the combination of a lower inventory cost and a higher adverse selection cost. Consistent with the increased information asymmetry, stock prices become more efficient. These results are driven by investors’ adoption of a more aggressive trading strategy. The paper thus provides a comprehensive examination of the implications of price limits