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| Price Limit Rule of Chinese A-Share and Investors' Disposition Effect |
| XIAO Xinrong, ZHOU Yanyi
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| China School of Banking and Finance, University of International Business and Economics |
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Abstract The price limit rule of A-shares was introduced in 1996, initially aimed at preventing drastic price fluctuations and controlling market risk, while avoiding panic selling by investors. However, numerous studies have shown that when stock prices hit the price limit, rather than reducing volatility or curbing speculative trading, the rule impairs the market's price discovery function, and even produces a “magnet effect”. Moreover, when stock prices approach the limit, they often trigger a series of irrational trading behaviors among investors, with the disposition effect being one such behavior.
According to the disposition effect, investors tend to sell stocks with higher unrealized gains more frequently than those with lower gains. The occurrence of a price ceiling event can capture investor attention, thereby potentially reinforcing the positive relation between the unrealized gains and investors' selling behavior, i.e. disposition effect. Despite price floor events also drawing investor attention, due to the disposition effect investors are more sensitive to gains than losses,and the impact of lower price limits on the relation between unrealized losses and investors' selling behavior is weaker.
However, related research mainly focvces on the direct impact of price limit events on investors' trading behavior, with less attention given to the effect of the price limit rule on the disposition effect. Therefore, this paper utilizes the stock data of the Chinese A-share Main Board and Growth Enterprise Board from January 2005 to November 2023 and systematically studies the effects of the price limit rule on the disposition effect.
First, we assess the disposition effect by analyzing the relation between unrealized gains or losses in stocks and investors' selling behavior, revealing that the price limit rule amplifies the disposition effect among investors. Additionally, we employ the relaxation of price limit on the Chinese A-share Growth Enterprise Board as a quasi-natural experiment, providing further evidence that the price limit rule strengthens investors' disposition effect. Second, we explore the mechanism by which the price limit rule influences investors' disposition effect. Specifically, we use the number of daily price limit events and the occurrence of stocks being listed on the Dragon-Tiger List to measure how much the rule captures investor attention. It was found that the rule strengthens the disposition effect by drawing investor attention to specific stocks. Third, we investigate differences in how the price limit rule impacts the disposition effect across rational and irrational investors. By analyzing the transaction volumes of individual sell orders, we categorize sellers into institutional and individual investors. The results indicate that the amplification of the disposition effect primarily occurs among individual investors rather than institutional ones. Finally, we examine the impact of the price limit rule on asset pricing by reinforcing the disposition effect. The findings suggest that during price ceiling events, investors are more inclined to sell stocks with high unrealized gains, leading to temporary undervaluation and thus higher future returns. In contrast, during price floor events, the impact on the relation between unrealized losses and future returns is weak.
Compared to existing research, this paper offers three potential contributions. First, from a theoretical perspective, we examine the impact of the price limit rule on the disposition effect and its underlying mechanism. While previous research has primarily focused on the direct effects of price limit events on investors' trading behavior, this paper extends the analysis by investigating the influence of the price limit rule on the disposition effect, thereby enriching our understanding of the rule's impact on investor behavior and asset pricing. Second, from an empirical perspective, we measure the disposition effect using the relation between unrealized gains or losses and the proportion of stocks sold by investors. Previous studies, both domestically and internationally, have commonly relied on account-level data to directly measure the disposition effect by examining the relation between specific investors' holding gains or losses and their selling behavior. Given the non-public nature of account-level data, this paper adopts an approach that measures the disposition effect by analyzing the relation between the average unrealized gains or losses of current holders in specific stocks and their selling behavior, providing broader applicability. Finally, from a practical perspective, the findings of this paper offer valuable insights for all participants in the Chinese A-share market. The results provide further evidence that the price limit rule amplifies irrational trading behaviors among investors, underscoring the need for reforms to the price limit rule. Moreover, the conclusions provide significant implications for investors' decision-making in the information-oriented financial market.
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Received: 03 April 2024
Published: 02 October 2024
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