An Anatomy of the Magnet Effect: Evidence from the Korea Stock Exchange High-Frequency Data

Abstract

The magnet effect is previously defined as the accelerated trading behavior when stock prices move close to the limit prices but empirical evidence is scarce and mixed. In our paper, we examine the existence and the forms of the magnet effect using the limit order book and transaction files of the Korea Stock Exchange. We delineate the process of the magnet effect from multiple dimensions: rate of return, trading volume, volatility, order flow, and order type. We conclude that a significant magnet effect exists in all dimensions when the limit hit becomes imminent. Investors place increasingly more orders, choose proportionally more market orders and frequently reposition existing orders to advance transactions prior to the limit hits, especially from the side of the market that ultimately leads to the limit hits. As a result, stock prices accelerate to the limit prices and price volatility rises as well. Our results on the rate of return and volatility are robust after controlling for serial correlation and volatility clustering. In addition, strong evidence is presented to illustrate that: (i) a narrower price limit band features higher acceleration rates in all dimensions of the magnet effect than a wider price limit band; and (ii) the upper limit hits draw heavier volume of transactions and have longer persistence of the magnet effect than the lower limit hits. Lastly, we do not find similar acceleration trajectories within large price movement days on the New York Stock Exchange, confirming that the magnet effect is a phenomenon unique to the markets with daily price limit systems.