A review of regulatory mechanisms to control the volatility of prices
Today's attention focuses on stock price
volatility. As in earlier years, the proposals
garnering most of the attention seek to control
stock price volatility by regulating futures
markets, particularly stock-index fitures contracts.
This article reviews the evidence on
three mechanisms that have been proposed to
control price volatility. The first is to increase
margin levels. Proponents of this mechanism
argue that higher margins would discourage
destabilizing speculation. A second proposed
mechanism is to set price limits or "circuit
breakers" in futures markets. Proponents of
this approach claim it would allow markets to
cool off. A third proposed mechanism is to
impose a tax on each transaction of a futures
contract. Casual descriptions of transactions
taxes refer to them as solving volatility by
throwing sand in the gears of the futures market.
In the sections that follow, we assess the
existing research on each of these three methods
and their underlying rationales.