Limits to linear price behavior: Futures prices regulated by limits

Abstract

This article analyzes the behavior of futures prices when the exchange is regulated by price limits. With a model analogous to exchange-rate target-zone models, we tested for the existence of a nonlinear S-shape relation between observed and theoretical futures prices. This phenomenon reflects the adjustments in traders' expectations even when limits are not actually hit. The approach is illustrated for five agricultural futures contracts traded at the Chicago Board of Trade. There is some evidence of nonlinearity in quiet periods. In cases of fundamental realignments, that is, volatile periods, this nonlinearity disappears. © 2001 John Wiley & Sons, Inc.