Circuit Breakers, Trading Collars, and Volatility Transmission Across Markets: Evidence from NYSE Rule 80A

• Author: Michael A. Goldstein
• DOI: http://doi.org/10.1111/fire.12074
• Date: 01 August 2015
• Published date: 01 August 2015

The Financial Review 50 (2015) 459–479

Circuit Breakers, Trading Collars, and

Volatility Transmission Across Markets:

Evidence from NYSE Rule 80A

Michael A. Goldstein

Babson College

Abstract

The NYSE’s Rule 80A attempted to delink the futures and equity markets by limiting

index arbitrage trades in the same direction as the last trade to reduce stock market volatility.

Rule 80A leads to a small but statistically significant decline in intraday U.S. equity market

volatility.In addition, the results are asymmetric: volatility is dampened more in a rising market

than in a declining one. These results suggest that, to a limited extent, rule restrictions on trading

can sufficiently delink the futures and equity markets enough to reduce the transmission of

volatility.

Keywords: circuit breakers, trading collars, trading halts, NYSE Rule 80A, microstructure,

volatility transmission

JEL Classifications: G18, G19, G24, G28

Corresponding author: Finance Department, Babson College,231 Forest Street, Babson Park, MA 02457-

0310; Phone: (781) 239-4402; Fax: (781) 239-5004; E-mail: goldstein@babson.edu.

The author would like to thank Mark Ventimiglia,formerly of the International and Research Division of

the NYSE, for providing the data for this study and Alejandro Latorre, formerly of the Capital Markets

Function of the Federal Reserve Bank of New Yorkfor excellent research assistance. Additional thanks go

to Robert VanNess (the editor), Joan Evans, James Mahoney, and participants at the Second Joint Central

Bank Research Conference on Risk Measurement and Systematic Risk in Tokyo, Japan. Much of this

analysis was completed when the author was the VisitingEconomist at the NYSE. The views expressed in

this paper do not necessarily reflect those of the NYSE. An early version of this paper was titled “Circuit

Breakers, Volatility, and the U.S. Equity Markets: Evidence from NYSE Rule 80A.”

C2015 The Eastern Finance Association 459

460 M. A. Goldstein/The Financial Review 50 (2015) 459–479

1. Introduction

For almost 30 years, a consistent concern for regulators and practitioners alike

has been the possibility of the transmission of volatility from the derivatives markets

(such as the futures market) to the primary market (such as the equity market), and

for good reason. The October 19, 1987 Black Monday market crash was blamed on

program trading and the selling of stock index futures due to portfolio insurance,

some of which was arbitraging the difference in prices between the Chicago futures

market and the equity markets in New York.1The Presidential Task Force on Market

Mechanisms (1988), commonly called the Brady Commission Report, noted that

"[s]elling pressure in the futures market was transmitted to the stock market by

the mechanism of index arbitrage" (p. v).2Over two decades later, the joint report

by the Securities and Exchange Commission and the Commodity Futures Trading

Commission (2010) notes that the May 6, 2010 Flash Crash was also due to volatility

transmission from the Standard & Poor’s 500 (S&P 500) futures market to the equity

markets.

The October 1987 Market Crash and the May 2010 Flash Crash demonstrate

the notable effects of volatility transmission from the futures markets to the eq-

uity markets. Despite the distance between Chicago and New York, the increased

use of computerization of the markets and their linkages has caused movements

in the Chicago futures markets to impact prices in the New York equity markets

with increasing speed. Laughlin, Aguirre and Grundfest (2014) examine information

transmission from the Chicago futures markets to the New York equity markets, and

show that in April 2010 (immediately prior to the May 2010 Flash Crash) trades in

the futures markets in Chicago impacted equity prices in New York within 7.25 to

8 milliseconds later. They also showthat by August 2012 (after the Flash Crash), due

to increasingly sophisticated microwave towers that are increasingly better located,

the data indicate that this transmission time dropped to 4.2 to 5.2 milliseconds.3

Given the impact of the linkages across these markets, an interesting question is

whether rules and regulations could delink the futures and equity markets in such a

1On the 20th anniversary of the 1987 Crash, NYU Professor Richard Sylla noted in Lobb (2007): “The

internal reasons included innovations with index futures and portfolio insurance. I’ve seen accounts that

maybe roughly half the trading on that day was a small number of institutions with portfolio insurance.

Big guys were dumping their stock. Also, the futures market in Chicago was even lower than the stock

market, and people tried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in

the New Yorkcash market. It made it hard – the portfolio insurance people were also trying to sell their

stock at the same time.”

2In addition, the Presidential Task Force on Market Mechanisms (1988) emphasized that these markets

are linked and integrated: “[f]rom an economic viewpoint, what have been traditionally seen as separate

markets — the markets for stocks, stock index futures, and stock options — are in fact one market” (p. vi).

3Laughlin, Aguirre and Grundfest (2014) suggest that future improvements could drop the time to about

4.03 milliseconds, approaching the theoretical minimum of 3.93 milliseconds that is limited by the speed

of light. See Angel (2014) for a further discussion of the impact of regulation related to the intersection of

physics and finance.