A note on price limit performance: The case of illiquid stocks

In the Chinese stock markets, there are A-shares and B-shares. Both share-types have identical cash flow rights but different ownership structures (i.e., A-shares are owned by local Chinese citizens and B-shares are owned primarily by foreigners), causing B-shares to be less liquid relative to A-shares. However, even though B-shares have much wider bid-ask spreads than A-shares, both share-types are subject to the same 10% daily price limit regulation. As such, B-shares, simply due to their wider spreads, may be more inclined than A-shares to hit price limits. Our empirical results support this contention. The findings have policy implications. First, given wide spreads for illiquid stocks, exchanges may consider using midpoint prices (between bid and ask prices) to establish price limit ranges for illiquid stocks. In addition, and perhaps more importantly, exchanges may consider using wider price limits for less liquid classes of stocks.