LAUSR

Abstract We examine how traders react to two prominent stock market regulations. Under a constant fundamental value (FV) process, price limits and trading restrictions significantly reduce the price level and mispricing size when traders are inexperienced. Under a Markov-process FV, there is no evidence for these regulations to reduce mispricing. The novel Markov process also serves as a testbed for several financial hypotheses related to the regulations. We find that price limits do not improve reactions to market news and the binding of price limits magnifies the momentum in the price movements. These findings suggest that the scope of these regulations is limited and that they can backfire in some market environments.