Price Limit Expansion, Volatility Reversal, and Magnet Effect: A Theoretical Approach

Abstract

We investigate the impact of price limit expansion on stocks’ realized volatility, uniquely integrating both magnet effect and correction effect into our model. Our findings reveal that price limit expansion may increase or decrease stock volatility, with the magnet effect and stocks’ inherent volatility levels as primary driving forces, and the correction effect playing a minor role. Typically, a decrease in volatility occurs when a stock’s inherent volatility is moderate (i.e., neither too high nor too low), while an increase takes place when it is relatively high. We offer an insightful explanation of these contrasting behaviors in relation to the magnet effect and stocks’ inherent volatility.