Daily price limits and stock price behavior: evidence from the Taiwan stock exchange

Contrarian strategies and investor overreaction under price limits

“…Our empirical findings support the overreaction effect. There is evidence of delayed overreaction, indicating price continuations for the overnight period and price reversals for the subsequent trading day, consistent with Huang et al (2001) who investigate price behavior of limit-hit stocks in Taiwan from 1990 to 1996. This paper extends Huang's study and investigates the relationship between limit-hit behavior and firm characteristics.…”

“…The up-hit strategy is to short sell stocks that hit their upward price limits at the time the limits are hit (during time t) and then to buy these stocks back at the open prices the subsequent trading day (time t+1). Huang et al (2001) hypothesize that since price limits delay overreaction, overnight open prices will continue to move in the same direction but close prices will reverse the subsequent trading day. Because trading of limit-hit-lock stocks is suspended during the overnight period and noise traders are unable to identify the intrinsic value of these stocks, the limit-hit-lock stocks are likely to continue to follow the past pattern when these stocks restart trading upon the opening the next trading day.…”

“…The finding provides strong evidence that price limits interfere with trading, slow the process of prices fully reflecting news, and lead to price continuation for hit-lock stocks. Huang et al (2001) argue that overnight price momentum is not necessarily inconsistent with the overreaction effect since overreaction could be delayed until the intrinsic value is revealed by informed investors in the subsequent trading day.…”

“…In addition, since the range of price limits (7%) on Taiwan's stock market is smaller than on other stock markets such as Japan (20%) and China (10%), the chance that stocks will hit their price limits is relatively high in Taiwan (Cho et al 2003). Other studies of price limits, such as Kim and Limpaphayom (2000), Huang et al (2001), and Lee and Chou (2004) also have recognized the advantages of Taiwan's stock market for price limit analysis.…”

“…After limit-lock days, there is no evidence of price reversion, suggesting that price limits slow the price discovery process. Analyzing daily stock prices of the Taiwan Stock Exchange, Huang et al (2001) find that investors' overreaction is related to price limits and that overnight price overshooting of limit-hit stocks tends to be corrected the subsequent trading days. Others find opposing evidence.…”