The failure of the Chinese stockmarket circuit breaker mechanism was due to market participants' limited understanding of the dynamics of the stockmarket and a failure to get the rules and regulations right, according to Nobel Laureate Joseph Stiglitz.

After China scrapped its barely week-old stockmarket circuit breaker on Thursday, Chinese stocks continued its fall with the CSI 300 (China Securities Index) closing down 5.03% on January 11.

Stiglitz: If you don’t get the rules and the regulations right you can make markets more volatile

Originally aimed at solidifying market stability, China's circuit breaker system has been the focus of a lot of scrutiny internationally following a rocky 2016 start that saw the world's second largest economy halt trading activity twice in a single week. As a result of the volatility, the China Securities Regulatory Commission announced on January 7 that it was lifting the use of circuit breakers in its markets.

Under China's circuit breaker rule a 5% move up or down on the CSI 300 would trigger a 15 minute suspension of trading. If the index moved up or down 7% then trading would be suspended for a day.

The latest bouts of stockmarket volatility highlights another important scenario in China's road to financial maturity as it looks to find the appropriate regulations to govern its capital markets. "Markets whether they are markets with American characteristics or Chinese characteristics are very volatile," explains Stiglitz. "If you don't get the rules and the regulations right you can make markets more volatile."

For Stiglitz, the recent China circuit breaker issue was due to market participants' limited understanding of the dynamics of the stockmarket. "One of the problems in China is that there were two levels of circuit breakers and they were too close to each other," highlights Stiglitz. "So when one [level] got triggered everyone thought that the other one would likely be triggered so they rushed to get out. They needed to be separated out more than they were."

By comparison, the US, which instituted its own circuit breakers after its market crashed in 1987 had wider parameters governing its capital markets. The Standard & Poor's 500 Index temporarily stops trading after a 7% drop then again at 13%. Trading is suspended only after a 20% fall.

"Advanced countries have been learning about this for a very long time," notes Stiglitz. "They still haven't gotten this right as we saw in 2008 with the global financial crisis. It shows how difficult it is to get the rules and regulations correct. It's a learning experience and is something that China has to learn."

While the sudden drop in the stockmarket is a shock to the country's mostly domestic investor base, it isn't necessarily reflective of the country's economic health overall. "What happens in financial markets can often be disconnected to what is happening in the real economy. We saw that in United States when the stock market went up after 2009," says Stiglitz. "Most people didn't see improvement in their lives. In the first three years after the crisis the stock market did very well but 91% of the gain went to the top 1% of America, 99% of Americans saw nothing happening."

See also our China stockmarket circuit breaker needs fine-tuning story by clicking here