Tuesday, May 19, 2009

Time to question circuit breakers

I wrote a piece in Financial Express titled Time to question circuit breakers where I look at the costs and benefits of the existing `circuit breaker' regime on the stock market, and offer two alternatives for improvement.

1. Extremely timely article by Prof Shah, indeed !

It is lighthouse pointing to right direction for exchanges/regulators!

By pure happenstance, I chanced upon two links:

Scholarly thesis of Jong-Won Yoon->

Circuit Breakers and Price Discovery - Theory and Evidence by Jong-Won Yoon of UCLA - in 1994"Policy Implications ->

Chapter 7 of same thesisWay to go...

Best,
Manu Bhat
IIFT

2. While all arguments put up are quite convincing and correct to some extent, one thing needs to be noted that most of the financial crises in the world have arisen for the overtrading. One of the features of overtrading is excessive price rise.

The circuit filters precisely takes care of this issue. For the matter there should be attempts to limiting the trading frenzy after such events, especially to limit the overall risk on the system.

It is very well justified that circuit filters be put in , to allow rational digestion of news. Some loss of trading is much better than trade now and repent later.

3. Dear Anonymous,

Call auctions advocated by Prof Shah create inbuilt moderation and modulation in trading while maintaining continuity of process in stock exchange.

It also obviates buildup of news pile for cascading/repetitive effect in circuit breakers after halting trading which hinders transmutation of information into price on an ongoing basis.

Systemic moderation and normalcy restoration is far better than abrupt shutdown on threshold and release of action with plausible repeat events !

Trading perceptions when continuous with feedback loop during sporadic movements, are the best stabilising and rationalising factor that can be brought to play; instead of shutdown for a clean break from past which doesn't usually yield smoothness due to loss of continuity and involvement discounting incoming news-streams !

Best,
Manu Bhat
IIFT

4. Dear Ajay,

One of the reasons Circuit Breakers were put in place was to avoid a debacle like that of 1987 market crash.

The very fact that the circuit breakers have been applied only a few times is a proof that you do not really need a new system.Is an event like Lehman's fall good enough to comprehend in 15 minutes, I doubt that.

5. I doubt if Ajay would have had the same thoughts on 17th May 04 as 18th 09.
One thing that can be certainly questioned is the duration of suspension. It is unfair for Indian investors that their own home market is denied to them while parts of it are available in Singapore and US. Is this the way towards MIFC by shifting our markets overseas at critical times?

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7. Hi Arun,

Aren't all of us more aware and awake about global debacles as on 18th May '09 than 17th May '09; which doesn't preclude prescience of Prof Shah ?

Usually, isn't our hindsight always stronger than our foresight ?

Prof Shah is merely casting his insight about domestic trading stoppage inducing invalid trade price info continuity status and its unintended benefit transference and accrual overseas, as pointed out by you too.

I think Prof Shah is truly panoptic in his judgment !

Cheers,
Manu Bhat
IIFT

8. Call Auctions are good idea.

However, Another idea that is being discussed is that after cooling of period stipulated by exchange/regulator. Market may reopen as a new settlement on the same day, where all shares should be strictly traded as Trade to Trade with compulsory payment or delivery for that particular day. we may then be able to ensure price discovery and liquidity.

9. Ajay,

I just love the "call auction" idea. Would you recommend it for individual shares as well? I'm thinking of all those small cap shares with absurd 5% circuit breaker levels that barely trade at all most days of the week (either because there are no orders or there are too many and it's circuited)...

10. Hi Manu
Certainly one is wiser with time. But the point is not that. It is more to do with the Bear and Bull. when market is falling there is not much objection to market being controlled and finance ministers personally visit Stock exchanges to calm the neves. In euphoric times, ministers predict one day in advance that markets are going to rise by at least 1000 points.

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