Grounded Theory

Background of Grounded Theory 

The roots of grounded theory are in sociology, originating from theoretical experimentations with symbolic interactionism[1] (Charmaz, 2014; Chamberlain-Salaun, Mills, and Usher, 2013). The social processes adumbrated by symbolic interactionism portray social processes with concrete structures, containing implicit or explicit codes of conduct, and procedures which demarcate how interactions reveal and cast the meanings from them. Developing from this premise, grounded theory slowly emerged as an attempt to erect explanatory theories of simple, basic, and elementary social processes by studying them in their natural environments (Glaser and Strauss, 1967, 2009; Glaser, 1978; Zarif, 2012). One of its earliest proponents Strauss and Corbin describe grounded theory as a collection of 6 Cs: causes, contexts, contingencies, consequences, co-variances, and conditions. The 6 Cs enable a researcher to understand the patterns and relationships among those elements (Boychuk, and Morgan; 2004; Klag and Langley, 2013). For grounded theorists knowledge of social realities is achieved through watchful observation of behavior and speech practices. 

Advantages of Grounded Theory

 Personally, I find grounded theory to be charmingly simple, intuitively attractive, and conducive to creativity. It is also conceptually strong, and I particularly enjoy its highly structured approach to concomitant data collection and analysis, which allows rich and deep data to evolve into a theory. However, before delving into detailed pros and cons of grounded theory, a brief historical consideration is warranted. First of all, within qualitative framework, grounded theory first appeared as a protest toward passive acceptance by researchers of all “great theories” popular at the time, and the certitude that researchers only need to test the theories through quantitative scientific procedures. Earliest grounded theorists endeavored to counter this inaction by subjecting research data to rigorous analysis with a view to developing theoretical analysis (Charmaz, 2003, 2011). Thus grounded theory can be understood as a way of thinking about data in order to conceptualize it (El Hussein, 2015). To accomplish this data is continuously subjected to interrogation until a theory surfaces (Bryant and Charmaz, 2007). Having mentioned this, let us now explore the merits of grounded theory as a method of inquiry in greater details.

Pro: Inductive Simplicity

Unlike the hypothetico-deductive approach of dominant positivist culture of 3-4 decades ago, grounded theorists extol the potency of inductive reasoning (Charmaz, 2014; Hussein and Hirst, 2016). Though grounded theorists share the affinity for inductive logic with other qualitative colleagues, they posit that researchers should not begin research with a hypothesis or theory and then test if it upholds or not; they should rather first begin with data collection in the research’s native environment, simultaneously analyze it, and finally generate a hypothesis (Smith, 2015; Locke, 2015; Halcomb, 2016). Glaser calls this an enjoyable, meaningful, informative, and empowering venture and claims its appeal lies in the facts of its fitness and simplicity (Glaser and Strauss, 1998). Therefore, much like Nike’s slogan, a research can “just do it” (Glaser, 1998).

Pro: Intuitive Brilliance

Urquhart, Lehmann, and Myers (2009) point out that grounded theory is intuitively appealing to beginner researchers because it allows them to be engrossed deeply in the data. This makes the researcher continuously compare, code, and memo throughout the research term. This echoes Charmaz’s (2006) earlier remark that grounded theory equips neophyte researchers with the necessary principles and heuristic devices to start a research, remain committed to it, and finish it timely. Charmaz further contrasts this with other approaches within qualitative traditions which make researchers treat data however they want—this makes the research process haphazard. Morse, Stern, Corbin, Bowers, Clarke, and Charmaz (2009) further comment that for reasons stated by Charmaz (2006) grounded theory lets new researchers successfully answer their predefined questions, enlighten their thinking process, and reassure them when they hesitate during the actual research experience. Finally, the fact that grounded theory can be applied to almost all disciplines of study and is compatible with any type of data demonstrates its wide applicability (Glaser, 1992).

Pro: Creativity

A common complaint of grounded theorists with other strands in qualitative and quantitative approaches is of bias springing from a priori assumptions. Grounded theory sidesteps this problem by virtue of completely disregarding existing hypotheses at the beginning of research. Instead it utilizes empirical data to produce concepts. Pioneers of grounded theory—in particular, Glaser (1978)—encourages the neophyte researcher to shun preconceived theoretical data to augment creativity and invest time toward generating new ideas. Morse (2009) also encourages grounded theorists to tread along a process of discovery where themes and interpretations logically surface from the data. Thus researchers can develop meaning from the data and analyze it concurrently via creative, inductive processes. Kriflik, Zanko, and Jones (2005) credit this sequence for leading to original findings from the data compared to grounded theory’s sister qualitative approaches.

Pro: Superior Conceptualization

If the reader remembers the introductory section of this paper, the father of symbolic interactionism, Herbert Blumer (1969b) criticized the culture of imprecise conceptualization and blamed it for most of scientific difficulties faced by researchers in a post-positivist era (Snow, 2001). Grounded theorists concurred with this (Strauss and Corbin, 1994; Bowen, 2006) by pointing out that the prime problem in research process for finding an answer is badly defined concepts which obstruct generating precise, agreeable, and realistic interpretation of empirical social (subjective) data. Blumer (1969a, 1969b) prescribed one remedy to this disease: simplification. Simplification of concepts occurs when the relevant is sieved from the irrelevant. Through abundant practice of constant comparison and frequent memo-ing, grounded theory fosters a persistent back-and-forth of data collection and data analysis (Charmaz, 2014; Creswell, 2015). This furnishes concepts with broadening power which are easier to remember and are applicable to a wide range of events. It also facilitates transferability of those concepts to previously unexplored milieus. Grounded theorists today claim one of the greatest achievements of grounded theory to be Glaser and Strauss’s unremitting emphasis on concept generation and its legitimacy in mainstream methodological discourse (Timmermans and Tavory, 2012; Ruppel and Mey, 2015; Charmaz, 2014; Schwandt, 2015). Superior conceptualization is also a unique attribute which makes grounded theory stand apart from its qualitative sister methods.

Pro: Systematic Insight into Reality

Unlike many qualitative methods which rely on broad principles making application and interpretation cumbrous, grounded theory benefits from a robust, structured, and systematic approach to data analysis. The earliest definitions of grounded theory from its pioneers[2] demonstrate the level of emphasis given to the “systematic” nature of both theory generation and procedures to allow for inductive insight into a phenomenon. This improves the efficacy of data analysis to judge, generalize, and compare the results of grounded theory studies. It also helps with ensuring rigor and trustworthiness in the emergent theory (Rolfe, 2006; Cooney, 2011; Starts and Trinidad, 2007.) Stebbins (2001), Denk, Kaufmann, and Carter (2012) point out that the systematic approach distinguishes accidental discovery from deliberate exploration congruent with epistemological and ontological underpinnings of the researcher. The systematic approach is purposive, wide-ranging, and product of forethought. The serendipity approach of accidental discovery, although still scientific, suffers from waste of time and resources because of its overt reliance on fortune—waiting for the Archimedes-like Eureka moment. The grounded theorist, contrarily, places himself/herself actively on the path to discovery.

Pro: Deep and Rich Data

The adventure of research begins with finding data. This data helps dig out the context and structure of informants’’ lives while revealing their feelings, opinions, perspectives, intentions, actions, etc. Thick descriptions are required to procure rich data. Geertz (1973), Charmaz and Mitchell (2001), as well as Corbin and Strauss (1990) recommend taking extensive field notes during observation, gathering narratives from interviews, and assembling respondents’ written personal accounts. Grounded theory makes use of all the techniques above to make sense of the data. But it doesn’t just stop there. It also polishes it to produce insight into participants’ world. Grounded theory underscores data’s coexistence with context to expose what lies beneath the surface. This makes the world appear anew by extracting respondents’ social and subjective life (Charmaz, 2006). Extricating multiple views of participants’ gamut of actions empowers researchers to develop analytic categories to compare data to percolate new ideas (Holton, 2006). Grounded theory fosters this desire by goading the researcher to illumine the otherwise inaccessible views of informants’ lives. Grounded theory stimulates researchers to go back to the data and venture into analysis to decide whether more data is needed to enhance the emerging theoretical framework. This endows researchers with a renewed outlook and creates innovative categories and concepts.

Pro: Pro-Exploration

The grounded theory approach is ideal for exploration. Since it delivers a methodology to develop an understanding of social occurrences which are not pre-defined or pre-theoretically ossified with existing theories and paradigms, it offers a good platform for launching exploratory studies (Engward, 2013.)  This makes grounded theory suitable for examining social processes which have been neglected in mainstream research milieu, or where previous research is narrow or relatively scarce, or on topics where a fresh outlook promises deeper insight (Milliken, 2010). It also makes exploration easier because by definition it acknowledges the situated nature of knowledge and contingent nature of practice, as well as adapting easily to diverse phenomena.

Disadvantages of Grounded Theory

Although I am required to describe some of the weaknesses of ground theory for purpose of this assignment, I should disclose that I am indeed an advocate of grounded theory. Therefore, despite acknowledging its cons, I should point out that none of its demerits are fatal. They are limitations at best which can be overcome with careful attention to details, rigorous hard work, improved skill set, and experience. Some of grounded theory’s shortcomings are as follows.

Con: Exhaustive and Time-Consuming

Grounded theory usually produces huge sums of data which can be daunting to manage. Without proper training and requisite skills, using grounded theory can be a waste of time. Thus new researchers can become overwhelmed by the exhaustive coding requirements of grounded theory (Myers, 2013). Open coding requires not only a great deal of time, but also can be physically and mentally taxing (Charmaz, 2006; Walker and Myrick, 2006). Abstraction process regarding conceptualizations is quite demanding too. It is possible for novel researchers to be so immersed in coding that they can be oblivious to performing the job of discovering ideas and themes from where theory can emerge out of subjective social data. Moreover, grounded theory in hand of inexperienced researchers usually leads to generation of lower level theories. To overcome this, Annells (1996) recommends researchers to be patient and recognize that grounded theory is not “so simple.” It can take months if not years to tweak around the data to generate a theory regarding core themes. Annells (1997) also recommends undertaking grounded theory under the wings of an experienced mentor to share the burden of the journey.

Con: Methodological Pitfalls

Annels (1996, 1997) and Myers (2013) hint at the possibilities of novice researcher blurring methodological lines through using purposeful sampling and ignoring theory. Charmaz (2006) points out that while it is acceptable to begin a research with purposive sampling, the researcher should revert to theoretical sampling when data collection process is controlled by emerging theory. Failure in this department will result in shallow conceptual rigor. Researchers also often use small number of data sources and interviews. To avoid this problem Glaser (1992) suggests using both observation and interview for data collection. Failure to do so shifts focus from social process toward lived experiences of subjects.

Con: Literature Review

Grounded theorists themselves are divided whether to do literature review prior to beginning the actual research or not. Its founders Glaser and Strauss (1967) unambiguously urged researchers to write the literature review after finishing analysis so that it doesn’t pollute the findings of the study. Four decades later Corbin and Strauss (2008) echoed the sentiment by saying that there is always something new to discover. Thus they deem it unessential to conduct a full literature review before embarking on a research. Schreiber and Stern (2001) disagree with this position by claiming that theoretical sensitivity is important to avert personal biases, which can threaten the validity and credibility of a study. By sensitivity Schreiber and Stern mean researcher’s own insight into data, which can prepare him or her to interpret the data through own professional background, knowledge, and perspective (McCallin, 2003).

Con: Sub-schools within Grounded Theory

Having multiple traditions inside a school of thought is not inherently negative. However, the divergent educational backgrounds of Glaser and Strauss provoked a fissure inside the grounded theory tradition owing to the founders’ contrasting ontological and epistemological underpinnings. Till date, a minimum of 4 sub-schools[3] can be listed—most prominent being “original” school by Glaser and Strauss (now held only by Glaser who assiduously continues to promulgate the original story), the rebellious Strauss and Corbin school, and the constructivist school. The intra-school debates are mainly concerning verification and conceptual differences in understanding what theory entails. This can be very confusing to the new researcher both prior to beginning the research to determine research question and objectives as well as mid-way through the research during coding and analysis.

Con: Generalizability

Broadly speaking, qualitative researchers care less about generalizability. This is more in quantitative domain. Research questions explored via the lenses of grounded theory enable a unique scope of exploration and reveal potentially intricate and high level concepts which are not restrainted to a particular respondent or environment. Glaser (2002), Ayres, Kavanagh, and Knafl (2003) disagree with their qualitative-minded colleagues that just like quantitative, final product of qualitative studies should be generalization too—no matter what language is used to represent it (Buetow, 2014). Similarly, Lipscomb (2012), Sandelowski and Leeman (2012), and Polit and Beck (2010) berated grounded theorists for their disregard for theory-testing. They believe that knowledge grows through testing and confirmation of theories. Simply building theories after theories without testing them is worthless to overall progress of science. These confirmations take place by systematic replication—the result of which either confirms or rejects the theory. Lack of concern for external validity and generalizability can thus threaten acceptance of a grounded theory oriented study.

Parting Remarks

Among the children of the qualitative family, grounded theory is arguably the most rebellious and controversial one. It stands out not only for its unorthodox meaning, understanding, and description of phenomena, but also for its inordinate emphasis on theory-production. This approach—like most scientific endeavors—has changed, refined, and evolved over the decades due to scientific community’s perception and treatment of knowledge. Compared to the 1960’s zeitgeist, science is much more humanized today. Facts are seldom taken at face value today unless they run the gauntlet of analysis and critique. Glaser’s original realist ontology is a polar opposite of Strauss and Corbin’s ontology—which is in tune with conventional qualitative researchers. This shift in attitude reflects the overall shift in scientific climate which now is more tolerant of subjectivist and constructed orientation of truth. As a former finance professional and current researcher, I can appreciate the richness the grounded theory movement has brought to the business schools. Finance Professors no longer outright balk at the prospect of research using grounded theories. Some admire, if not apply, it for its flexibility in data connection, analysis and interpretation in complex environments—particularly in my personal interest area of capital markets. Admitting my membership in the post-positivist club, I acknowledge that using grounded theory as a method of inquiry has the potential to furnish unparalleled insights into experiences of stakeholders in my own discipline of finance, and business/economics in general.

 

References

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Timmermans, S., & Tavory, I. (2012). Theory construction in qualitative research from grounded theory to abductive analysis. Sociological Theory,30(3), 167-186.

Urquhart, C., Lehmann, H., & Myers, M. D. (2010). Putting the ‘theory’ back into grounded theory: guidelines for grounded theory studies in information systems. Information systems journal, 20(4), 357-381.

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[1] A term coined by Herberrt Blumer outlining how people react toward matters based on what meanings things have to people and how those meanings are rooted in social interaction and modified continuously through interpretation. For a seminal overview of symbolic interactionism school, reader can peruse Stryker (1980).

[2] Glaser (1978) defined grounded theory as a systematic generation of theory from data itself obtained systematically from social research. Strauss and Corbin (1994) defined it is a qualitative research method that uses a systematized set of procedures.

[3] Discussing the diversity of intra-grounded-theory traditions is beyond the scope of this assignment. Nonetheless, an interested reader is invited to read an enlightening exposé on this by Ralph, Birks and Chapman (2015): The Methodological Dynamism of Grounded Theory. International Journal of Qualitative Methods, 14(4), 1609406915611576.

Circuit Breakers as Stability Levers

ABSTRACT

Circuit breaker, an automated regulatory instrument employed to deter panic, temper volatility, and prevent crashes, is controversial in financial markets. Proponents claim it provides a propitious time-out when price-levels are stressed and persuades traders to make rational trading decisions. Opponents demur its potency, dubbing it a barrier to laissez-faire price discovery process. Since conceptualization in 1970s and practice from 1980s, researchers focused mostly on its ability to allay panic, interference in trading, volatility transmission, prospect of self-fulfilling prophecy through gravitational pull towards itself, and delayed dissemination of information. Though financial economists are forked on circuit breakers’ usefulness, they’re a clear favorite among regulators, who downplay the reliability of anti-circuit-breaker findings citing, inter alia, suspect methodology and lack of statistical power. In the backdrop of 2007-2008 Crisis and 2010 Flash Crash, the drumbeats for more regulatory intervention in markets grew louder. Hence, it is unlikely that intervening mechanism like circuit breakers will ebb. But are circuit breakers worth it? This paper synthesizes three decades of theoretical and empirical works, underlines the limitations, issues, and methodological shortcomings undermining findings, attempts to explain regulatory rationale, and provides direction for future research in an increasingly complex market climate.

PROS & CONS

The integrity of a financial market relies heavily on the integrity of pricing. Prices determine worth, dictate where savings will be mobilized and channelized, resources will should be allocated, and liquidity will be sought or provided. Thus, when a market fails to facilitate price discovery and signaling to the extent that supply and demand no longer are the key determinants, a problem emerges. Therefore, regulatory intervention to iron out such kinks has merit. Nonetheless, whether the employed mechanisms have untoward consequences or fail to achieve professed objectives—or worse, impair market quality—warrants examination. The debate of whether circuit breakers are merited depends on a variety of factors:

Type of circuit breaker
o Is it a price limit or a trading halt?
o Is it a call auction?
o Is it discretionary or rule based?

• Triggering mechanism
o Is it induced by order?
o Is it induced by volume?
o Is it induced by price?

As of 2018—the time of writing this paper—data collected for Table 1 in this paper indicates 48 trading halts, 98 price limits, and 31 volatility interruption mechanisms active among the studied 152 exchanges, with some venues opting for multiple, overlapping, and/or discretionary schemes. In 16 cases, continuous trading is paused, leading to an auction. Meanwhile, with regards to trigger parameter, 11 venues activate the circuit breaker on discretionary basis; meaning pre-set values are not publicly disclosed.

Historically, the Brady Commission Report, sanctioned by Reagan administration in 1988 to uncover why the 1987 crash happened, was the first formal paper to advocate market-wide and individual circuit breakers. Latter proponents invoked the cooling-off hypothesis propounded by Ma, Rao, and Sears (1989), which argued circuit breakers could enforce price stability by curbing large price swings caused by speculative overreaction, avert panic, and dissuade price manipulation. Advocates also argue that traders’ ability to modify or withdraw standing limit orders during the halt enables informed traders to manage their risk without incurring losses, which in turn will increase liquidity and participation around equilibrium price upon resumption (Copeland & Galai, 1983). Moreover, circuit breakers are hoped to educate the market when channels of information transmission (i.e. quotes) are absent (Greenwald & Stein, 1988) and in so doing promote price discovery and decrease information asymmetry.

Both price limits and trading halts brake the price change mechanism. Whether this slowing-down is beneficial depends on the source of volatility. If the source is newly available fundamental information, the halt is only delaying the inevitable. Trade stoppage conveys no information on price expectations and could fuel further panic speculation resulting in greater transitory volatility when trade resumes. However, halt of trade before noise traders execute panic-driven orders would reduce transitory volatility and hence be desirable. Similarly, if excessive noise trades cause an order imbalance, halts could benefit the market by protecting noise traders from losses stemming from operating in a market with sub-optimal depth. Moreover, this allows market makers a chance to enter the market and provide liquidity (Kodres & O’Brien, 1994). In this scenario, Greenwald and Stein’s (1991) theoretical model shows informed traders’ transactional risk drops when prices move fast due to uninformed trades as value-seeking traders cautiously retreat since they are unsure at what price their trades will execute. Consequently, market participants have a greater incentive to be more informed before opening or closing a position.
Trading halts can also give brokers more time to collect margins. Brennan (1986) argued circuit breakers can act as a partial substitute for margin requirements if market participants are unsure about the eventual equilibrium prices during the timeout period. For example, a commodity trader posting 8% margin will lose all if price goes down by 20%. Should an 8% fall happen immediately, though the trader should lose his whole position, in practice, he only loses the 8% margin, and the broker stands to collect additional 12% later. However, with a circuit breaker of 10% in place, and neither the trader nor the broker knowing the eventual price trajectory to be 20% lower, the trader has an opportunity to attend to the first margin call voluntarily. This allows the broker multiple opportunities to collect margin when circuit breakers are in place. Failure to meet the margin call gives brokers more time to trade to stop the loss. Moreover, when a security or the market is in duress, stop-loss orders aggravate an already stressed order-book flooded with uninformed orders. In this way, trading halts can decrease transitory volatility. Moreover, an order-driven market may boast higher liquidity with a trading halt mechanism. In these markets, traders offering standing limit order suffuse liquidity. In normal circumstances, if price drops fast, a trader with standing limit orders will incur loss as the price continues to drop. However, a halt changes the mechanism from continuous to single-price auction upon resumption, when all orders are executed at the same settlement price. If a large selling order imbalance exists, all limit order buyers will receive it at the low clearing price. This protects the limit order buyers and encourages them to provide more liquidity in calmer market circumstances.

Contrarily, price limits and halts can increase transitory volatility if traders are afraid that trading will stop before they can submit order, leading to a hastening of order placement to increase the likelihood of execution. This triggers greater volatility, and rational traders recoil from trading amid fast-changing quotes. This phenomenon is known as the magnet effect, coined by Subrahmanyam (1994), who expanded on Lehmann’s (1989) predictions and later theoretically demonstrated this effect. He later postulated that rule-based halts are more susceptible to magnet effect due to higher predictability compared to discretion-based halts (Subrahmanyam, 1997).

There’s a possibility that informed traders may devote less time to monitoring the market if they know that they’ll be notified if trade is halted. Therefore, market liquidity may worsen in between trade halts, exacerbating transitory volatility, and leading—eventually—to more trade halts. For countries with multiple exchanges, a circuit breaker trigger in one market may cause perils in other exchanges. If only one market’s trade stops, order flow diverts to the remaining open market(s). Thus, solitary circuit breaker regimes may be counterproductive. Hence, many early researchers suggested coordination of regulation among exchanges to facilitate meeting higher demand for liquidity in multiple markets instead of one (Lauterbach & Ben-Zion, 1993).

Through a sequential microstructure trade model, Glosten and Milgrom (1985) demonstrate that uninformed traders acquire information by observing the trade process. Thus, trade contains an informational content, which is learnable only when trade is active. This leads to opponents arguing that absence of trade delays price discovery by postponing informed and uninformed agents’ reactions to new information (Fama, 1989). Moreover, if large price moves are induced by heavy one-sided order flow (i.e. order imbalance) and trigger a halt, informed traders are forced to temporize partial or full trading strategies, and whatever volatility was due to take place is splattered over subsequent trading sessions; typically with reduced liquidity (Chordia, Roll, & Subrahmanyam, 2002; Seasholes & Wu, 2007). Regarding this, Roll (1989) remarks: “…most investors would see little difference between a market that went down 20 percent in one day and a market that hit a 5 percent down limit four days in a row. Indeed, the former might very well be preferable.”

To sum up, opponents’ view on circuit breakers can be condensed into four points: volatility spillover across subsequent trading session, trading interference, delayed information transmission, gravitational pull or magnet effect hypothesis. After the flash crash of 2010, fresh questions surfaced as to whether the trading halt devices designed in rather simpler trading environments three decades ago are still relevant in today’s high frequency zeitgeist and, if not, to what extent should they be tailored, or should the regulators go back to the drawing board and start anew. The computerization of trading and liquidity provision, coupled with trade decentralization has led to a distinct rise in volume and volatility in the new climate (Brogaard, 2011). Regulators and markets in the US coordinated on a large-scale pilot project after the crash to investigate the efficacy of the classical circuit breaker regime vs. recalibrated narrow band of single stock price limits. Concurrently, European regulators took steps to move away from the endemic discrete circuit breaker regimes towards a unified framework to allow circuit breakers to operate across venues. To what extent this will succeed remains to be seen since exchanges have a vested interest in setting individual rules in a competitive environment to attract order flow. Nonetheless, Biais and Woolley (2011) posit that without tailor-made cross-platform streamlining across markets, circuit breakers cannot be effective anymore since in modern age of high-frequency trading arbitrage occurs across markets and suspending trade in the underlying spot while allowing the derivative trade can be dangerous.

UPSHOT

In the process of surveying for this paper, we have noted a striking similarity between the post-1987 crisis and post-2010 crisis understanding of circuit breakers. In both cases, much hullabaloo ensued in favor of greater regulation of equity and derivatives markets. In the 1990s, a slew of theoretical studies followed to understand if new measures would be beneficial, with a few empirical studies yielding ambiguous results. Paucity of data and a wide array of possible alternative explanations for sources of volatility meant that empirical studies lacked statistical power. In the next phase–new millennium–academia appeared to lose interest in the debate and very few theoretical studies were attempted, coinciding with lack of global crashes. It is interesting to note, however, that the dot-com bubble and crash didn’t inspire any circuit breaker studies. During 2000-2010, with growing availability of high-frequency data, soon a slew of empirical studies followed, mostly on Asian markets. Once again, the results were non-conclusive, though–on average–tilted against regulators. Meanwhile, around the same time, widespread adoption of circuit breakers took place (figure 2). In the final phase, 2010-today, empirical studies became more feasible due to greater availability of long time-series granular datasets, access to order books, limit-up-limit-down databases, and cooperation of exchanges. A noteworthy advancement in this stage has been considering insightful, new, alternative explanations for regulatory intervention and nuanced look at the circuit breaker regimes. Synthetic, laboratory market studies too were conducted, though some of its assumptions are questioned by researchers and industry practitioners. And yet the number of exchanges adopting circuit breakers kept growing, which is not surprising considering the post-crisis market climate. Therefore, now, the upshot is humanity’s understanding of circuit breaker mechanisms remains still limited and compared to the 1990s the progress has not been significant. In light of failure to address core methodological constraints plaguing empirical studies and relative disinterest in theoretical development, regulators defy or downplay academic findings and continue its practice, albeit with periodic tweaking. From a regulatory perspective, the circuit breaker issue is a foregone conclusion, although most are yet to provide empirical justification other than hopeful claims and windy rhetoric. It is not disputed that trading halts may ease the margin collection process for brokers (though others argue the benefits primarily in futures market cannot be generalized to equity), and that halts allow an opportunity to traders to reflect in turbulent times as well as protecting them from an informationally disorganized market when order flows surpass the market’s processing capacity. Innovations in processing capacity and trading algorithms has meant that many of these benefits are less relevant today. Besides, the benefits should be considered against the risk of neglecting the needs of hedgers, arbitrageurs, and investors participating on utilitarian motives, without whom the markets would be empty. Instruments impeding their trading ability are unlikely to be ultimately advantageous. Besides, speculation is necessary for market survival as it incentivizes competition for liquidity. Irrational as uninformed traders may be, denying them chance to participate hurts the informed traders in the long run as they miss out on profitable trading opportunities by exploiting the uninformed traders’ erroneous strategies. Moreover, protecting the interest of limit order traders should be considered as well. They perform a thankless job of providing liquidity and deserve to be compensated for it. Finally, the closing price of a security is a beacon for the economy. Intervention that distorts or impedes the process to discovering a rational price for a security imposes economic costs on the society. Large inter-day or intraday price swings are not necessarily bad or irrational. The cause of the price change matters more than its manifestation. Thus, demonizing volatility indiscriminately only serves to slow the price discovery and by extension result in subpar resource allocation in the economy.

Despite all the short-comings of circuit breaker schemes, innovative measures are on the way. After years of minor fine-tuning and incremental improvements, conceptually complex are and potentially superior mechanisms are garnering more attention. A one-size-fits all mechanism may not be far away. However, until such a solution arrives, circuit breakers are the best ad hoc measures available to stymie the erosion of market confidence. Hence, we conclude in words of Leinweber (2017): “Critics call them “Band-aids”, but for now, band-aids work.”

DOWNLOAD

The full version of the paper is downloadable at the journal’s webpage: https://doi.org/10.1002/ijfe.1709 

CITATION

Sifat, I. M., & Mohamad, A. (2018). Circuit Breakers as Stability Levers: A Survey of Research, Praxis, and Challenges. International Journal of Finance and Economics. https://doi.org/10.1002/ijfe.1709