This study shows how price limit rules, intended to stabilize markets, inadvertently distort price dynamics by fostering strategic speculation. Through a dynamic rational expectations model, we demonstrate that price limits induce post limit-up price jumps by impeding full information incorporation, enabling speculators to artificially push prices to upper bounds and exploit uninformed traders. The model predicts two distinct patterns: (1) stocks closing at price limits exhibit positive overnight returns followed by long-term reversals, and (2) stocks retreating from upper bounds suffer sharp reversals with partial recovery. Empirical analysis confirms these predictions. A natural experiment from China’s 2020 GEM reform —- which widened the price limit -— further provides causal evidence that relaxed limits mitigate speculative distortions.

This paper studies the magnet effect of market-wide circuit breakers and examines its possible forms using high-frequency data from the Chinese stock index futures market. Unlike previous studies that mainly analyzed the price trend and volatility, this paper is the first to consider the intraday price jump behavior in studying the magnet effect. We find that when a market-wide trading halt is imminent, the probability of a price decrease and the level of market volatility remain stable. However, the conditional probability of observing a price jump increases significantly, leading to a higher possibility of triggering market-wide circuit breakers, which is in support of the magnet effect hypothesis. In addition, we find a significant increase in liquidity demand and insignificant change in liquidity supply ahead of a market-wide trading halt, suggesting that the deterioration of market liquidity may play an important role in explaining the magnet effect.