Are price limits cooling off agricultural futures markets?

In the past few years, the lean hog and live cattle futures markets have experienced significantly heightened volatility and frequent limit moves. In this paper, we study whether price limits help resolve uncertainty and facilitate liquidity provision in the two markets and how they affect trading in the limit-free options market. In contrast to previous literature that is based on daily data, we use intraday futures and options data from 2014 to 2019 that allows for a better characterization of market behavior around limit moves. Consistent with microstructure theories, we find that price limits neither reduce volatility nor improve liquidity. Instead, they add to the high uncertainty that precedes the limit move, leading to significantly higher volatility and lower liquidity when trading resumes. Further, contrary to the notion that trading migrates to the limit-free options market, options volume drops and liquidity drains during limit moves. The options-implied futures price is only a biased, inefficient, and highly noisy estimate of the equilibrium futures price on locked-limit days. Overall, the findings suggest that rather than allowing the markets to cool off, price limits adversely affect market quality in presence of large price movements.