SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report DRAFT 9/14/2006
lower bid and ask depth for most size and activity levels. Thus, the bid and tick tests do not
affect liquidity in a way related to the size or activity level of a stock. Finally, the tick and bid
tests do not affect returns at or following the start of the Pilot whether the stocks are large or
small. On the other hand, the size and activity levels appear to matter for the effect of price
restrictions on volatility and for routing decisions. The bid test affects routing decisions more in
smaller stocks. Likewise, the bid and tick tests dampen permanent price volatility in small
stocks while amplifying it in large stocks.
The remainder of this report is organized as follows. In section II, we recount the history
of price restrictions, including Regulation SHO. Section III contains an overview of the
academic literature relating to the tick test and the bid test. The data and construction of the
samples are described in section IV. Section V explains the empirical methods used in the
analyses. In section VI, we present our main analysis of the effect of removing price restrictions
for pilot and control stocks over the first 6 months of the Pilot Period. More specifically, in
section VI-A, we present our analyses of how eliminating price restrictions has affected the
overall level of short volume and short interest, option market volume and open interest, and the
frequency and duration of upticks or upbids within the day. In section VI-B, we present our
analysis of how the removal of price restrictions has affected market quality, including measures
of spreads and intraday volatility. In section VI-C, we report our results on whether lifting price
restrictions has affected underlying stock prices or returns, the skewness of returns distributions,
the incidence of positive and negative spikes, and the tendency of positive and negative shocks to
subsequently reverse. In section VII, we investigate whether price restrictions affect all stocks
similarly or whether certain types of stocks, such as small stocks, are more affected by the rules.
Section VIII summarizes and concludes the report.
Prepared by the Office of Economic Analysis 11
DRAFT