Circuit Breakers and the COVID-19 Crisis

Abstract

Designed to curb extraordinary volatility, (stock-level) circuit breakers lead to unnecessary trading halts, which have been prevalent during the recent COVID-19 crisis. More importantly, while created to accommodate the dissemination of fundamental information to market participants, most trading halts turn out to be illiquidity events. Halts further lead to decreases in liquidity, and impede short-term price efficiency, with results being more pronounced in smaller, less liquid securities. Finally, trading halts in (some of the) S&P500 constituents are associated with jumps in SPY (SPY is an ETF that tracks the S&P500), a finding that has further implications for risk management. The paper concludes by providing some guidance on how to improve the existing market mechanism design in dealing with rare events such as the COVID-19 crisis.