Financial Markets: Setting Fuses May Be Small.

Financial market prices rise or fall beyond a certain limit, and the system of restrictions on pactions is collectively referred to as the fusing mechanism.

There are several forms of fusing mechanism: first, when the representative market index fluctuates beyond the pre-determined range, the whole market will suspend trading for a period of time; the second is the stock trading suspension system. The United States did not have such a rule in the past. But after the "crash" in May 6, 2010, it began to discuss the implementation of the suspension system for trading stocks, which was implemented after February 4, 2013, and the third is the stock price limit system, which is often referred to as the "price limit".

From January 1, 2016 onwards, Shanghai Stock Exchange, Shenzhen Stock Exchange and CICC will implement the index fusing mechanism.

At present, the thresholds of 5% and 7% set by the three exchanges may be too small.

Of course, only practice is the only way to test the pros and cons. Carrying out high quality research after implementation and optimizing it according to discovery is a common practice in the world.

More importantly, other supporting measures, such as timely and accurate disclosure of information on listed companies, and investor education, should also be improved to reduce the chance of the futile mechanism being triggered.

To control market volatility risk, the fusing mechanism is far from enough.

The pros and cons of fusing mechanism

The fusing mechanism is very different in different countries and regions.

As the first country to introduce fusing mechanism, the original intention of the United States is very simple. When securities prices are not related to economic fundamentals, the suspension of trading can prevent panic selling and give participants a cooling off period to restore confidence and trust.

But scholars firmly believe that the market is always effective. Scholars criticize the fusing mechanism to destroy the discovery process of securities prices and hinder market efficiency, and even think that the fusing mechanism has no effect.

A frequently cited example includes the closure of the Hong Kong stock market for a week after the black Monday of 1987 in the United States, but a 30% decline in the next opening.

However, scholars who supported the fusing mechanism pointed out that the US closed the stock market for another week after the "9 / 11" incident, and the market reaction was basically normal.

The idea of anti fusing mechanism also includes: when market pactions are suspended, there will be a variety of rumors and fallacies to increase market uncertainty; mutual funds and exchange trading funds should settle the redemption requirements every day. If the stock market stops trading, it will increase the pressure to deal with the redemption liquidity. The direct consequence is that these funds will be dealt with by reduction; the paction suspension may lead to cross market risk pmission, for example, when the A stock market is suspended, the Hong Kong stock market will take

The benchmark fund will lose its pricing benchmark, and the market maker will expand the spread and reduce the liquidity of the market.

A well designed trading pause system is not only to give investors a calm period to avoid panic, but also to provide trading time for trading partners who are willing to provide liquidity, thereby reducing paction risk and stabilizing the market. Many retail investors are not entirely rational. When they generally pursue price trends, they will lead to price deviations from value. Even institutional investors will show herd behavior and herding effect because of institutional arrangement, and limit stop can reduce such market failure. With the popularity of computer pactions in financial markets, some investment strategies will trigger sales orders when securities prices fall. If there is no fusing mechanism, snowball market crash may occur; and leveraged traders can not prevent margin traders from meeting the margin requirements because of excessive price fluctuation. Theoretical studies supporting the fusing mechanism can be summarized as follows.

It should be said that these theories are opposed to those objections.

The view is more convincing.

But another influential study has pointed out that the suspension of trading may lead to the "magneto effect": investors who originally planned to split into several trades may be attracted in advance because of the pause of the forthcoming trading, and the whole paction will be completed in one day, which will increase the price volatility (usually regarded as a bad thing), but the market liquidity before the paction will also increase (usually regarded as a good thing).

The study also pointed out that even if the magnet effect is more harmful than profit, there is a very simple solution, that is, the trigger conditions for the non public trading pause, which is done by the German Stock Exchange.

An obvious fact is that the researchers who conducted empirical analysis also showed strong herding effect, that is, few people were going to study those theories which were beneficial to the fusible mechanism, because it needed to know the type of information of investors, which was often difficult to obtain.

It is found that the disadvantages of the fusing mechanism only need to make use of publicly available price data.

In addition, almost all empirical studies have focused on the ups and downs.

Even so, scholars have not reached a consensus. Some studies have found that price limits will impede the price discovery process, reduce market liquidity, increase price volatility and generate spillover effects of price volatility. That is to say, once the stock rises and downs are triggered, the price volatility of these shares will rise on the next trading day.

An empirical study of the magneto effect shows that the magnetic effect of stock is more obvious in the market where there is a market for stop and stop, which is mainly manifested in the increase of stock price volatility and the increase of paction rate.

But there are Counterexamples in these studies.

In addition, there is an unsolved problem in the past studies, that is, the lack of a reasonable comparative reference system.

After the black market in 1987, the Hong Kong stock market closed for a week, and the opening market fell by 30%. However, it is impossible to know if the opening price of the Hong Kong stock exchange is not interrupted, the opening price of Tuesday will be much less than that of the 1987.

Now, some scholars have adopted very clever analytical methods to solve these problems which lack reference and comparison, and review the advantages and disadvantages of the fluctuation stop system.

A study published in 2013 pointed out the advantages of the A share trading system.

The author has concentrated on the time limit for the cancellation of the price limit and the share price of 1997~2000.

Their findings are: first, the rise and fall limit has eased the price fluctuation; second, a more stringent price limit has been beneficial to the ST stock market; third, the price limit system can help the market recover after a sharp fall (the index falls by more than 3% a day).

The author of this study also emphasized the third point is a great advantage of the price limit system.

These findings may be due to the fact that the investor structure of the A share market is mainly retail investors, while the investment period of institutional investors is also short-term.

In the final analysis, the advantages and disadvantages of the fusion mechanism exist.

However, the author believes that the A share market should try to break the market trading mechanism on the basis of the existing trading system. Taking into account the market structure of A share retail investors and the development of Computer Trading in A shares, it is still in the initial stage, and tends to have a bigger dividend than A.