The Impact of Price Limits on Foreign Currency Futures' Price Volatility and Market Efficiency

Chao Chen and Jau-Lian Jeng

The removal of the price limit for foreign currency futures on February 22, 1985 provides a unique opportunity to investigate the impacts of the imposed trading friction on the efficiency and volatility of the futures markets. This paper applies a new approach, the robust regression-based test, proposed by Wooldridge [21] to test the serial dependence in foreign currency futures price changes. Consistent with the efficient market hypothesis, the study finds no serial dependence in foreign currency price changes in the post-limit move period. The findings of the pre-limit move period are similar to the post-limit move period with the exception of German mark futures. Price limits may have induced serial dependence in German mark futures prices, but there is no serial dependence at all after the price limits are eliminated by the futures exchange in 1985. Moreover, the evidence indicates that the volatilities of foreign currency futures prices significantly increase after the removal of the price limits. Thus, the removal of price limits for foreign currency futures may only slightly improve the market efficiency at the cost of greater volatility.