Market circuit breakers are effective tools in times of heightened market volatility, according to new research from the World Federation of Exchanges (WFE).
The trade group for stock exchanges and other market infrastructure providers published a paper that examines the efficacy of circuit breakers that are triggered by market volatility and stress.
Most recently, these tools were activated by the turmoil that arose in the wake of the Covid-19 pandemic. Back in March 2020, the U.S. markets’ circuit breakers were triggered four times.
The WFE research into that episode, which focused on U.S. equity markets, finds that these mechanisms were generally successful in calming markets and restoring stable trading conditions.
“The research found that, on average, stock returns stabilize, selling pressure resolves, and prices become more informative after trading resumes from the market-wide trading halts,” the WFE said.
It also found that bid-ask spreads widen after the market circuit breakers are activated, “suggesting that liquidity suppliers increase the bid-ask spreads facing the increased uncertainty after the market halts trading.”
At the same time, the research also found evidence that the imminent imposition of circuit breakers doesn’t trigger panic.
Instead, it found that the speed of the market deterioration slows, suggesting that “traders tend to hold back from aggressive trading right before the trading halts…”
The research also compared the impact of market-wide circuit breakers with single-stock circuit breakers, finding that “liquidity suppliers tend to become more reluctant to provide liquidity after [market-wide circuit breakers] than after the single stock halts.”
“These results have important policy implications, as they indicate that the circuit breakers triggered during March 2020 contributed to alleviating the pressure in the financial market,” said Nandini Sukumar, CEO of the WFE, in a statement.
“We find that the circuit breakers in the U.S. are designed adequately and serve as an effective safeguarding mechanism employed by the exchanges,” she added.