SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report DRAFT 9/14/2006
on stock i at time t, and Rt L is the one-period return measured as a percentage of the lagged stock
price:
R
t
Pt
− P
=
P
t−1
t−1
P − P
=
L t t−1
R t
,
Pt
−2
where Pt represents the price of stock i at time t. We estimate these metrics using 5-minute and
30-minute horizons. The return as a percentage of the lagged price is used in the measure so that
the adjacent returns will be compared on the same basis. 49
We normalize the reversal measure by the standard deviation of returns on the same
stock, computed using the same return interval over which the reversals are measured, in order to
ensure that the measure will capture reversals that are large in magnitude compared to the typical
movement on the stock. The standard deviation is computed using only pre-pilot returns data, so
that the measure will not be affected by any changes in volatility that may be related to the pilot.
By definition, a “negative reversal” only occurs in periods when there is a negative return
followed by a positive return—otherwise, the negative reversal measure is equal to zero. If a
stock experienced a negative return of 3 standard deviations that was fully reversed in the next
period, our negative reversal measure would be 3. If a return is only partially reversed, only the
portion that is reversed is counted in the measure.
We do not test whether this measure changes across Pre-Pilot and Pilot Periods because
the Pre-Pilot Period is already used to normalize the measure. Rather, we focus on differences
between the control and pilot samples during the Pilot Period. In order to test whether the
frequency of extreme reversals differs across the two samples, we use a nonparametric
bootstrapping methodology that does not require any assumptions about the probability
49 For example, if a stock price increases from 40 to 50 and then returns back to 40, this corresponds to a 25% return
followed by a -20% return. In our measure, we would compute the negative return as a percentage of the original
price, which would make it a -25% return.
Prepared by the Office of Economic Analysis 31
DRAFT