SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report DRAFT 9/14/2006
Because the variance ratios relative to the daily level did not show any changes, the results on
transitory volatility are somewhat weak. However, the result for Listed Stocks over the five
minute horizon to thirty minute horizon still helps solidify the conclusion that the tick test
dampens transitory volatility over the five-minute horizon but seems to have no effect on
permanent volatility.
C. Effect on Stock Prices
As outlined in section III above, numerous theoretical models suggest that short selling
constraints can affect equilibrium stock prices. Some of these models predict that stocks are
likely to be more overpriced when short selling constraints are more binding, and when investors
disagree more about the stock’s true value.
Our evidence above suggests that price restrictions do constrain short selling somewhat.
Thus, we are interested in testing the hypothesis suggested by these theories, that removing price
restrictions will lessen overpricing. This hypothesis is not likely to hold unless the price
restrictions are significant relative to other short selling constraints and our sample stocks are
overpriced prior to the start of the pilot. Therefore, rejecting the hypothesis might mean that
price restrictions are minor relative to other short selling constraints or that our sample stocks
were not overpriced.
Table 8 reports average daily returns and average cumulative returns for pilot and control
stocks in the period surrounding the beginning of the pilot. If pilot stocks are over-valued
because of the price restrictions, these returns should be significantly negative for pilot stocks
relative to the control stocks. Cumulative returns are normalized to zero on April 29, the trading
day prior to the start of the pilot. As indicated in Panel A of Table 8, we observe for Listed
Prepared by the Office of Economic Analysis 45
DRAFT