SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report DRAFT 9/14/2006
frequency of reversals than control stocks. 56 If anything, the result is in the opposite direction—
for Listed Stocks at the higher threshold levels, there appears to be some evidence that there are
significantly fewer positive reversals for pilot stocks than control stocks.
As explained in Section V-D, above, our third approach to investigating whether
removing price restrictions increases the prevalence of price patterns consistent with market
manipulation is to use an autoregression model to estimate the extent to which positive and
negative returns tend to be reversed in subsequent periods. The results of this analysis are
presented in Table 12.
Panel A shows how five minute returns are correlated with the returns of each of five
previous five-minute periods. A positive number reflects returns in the same direction. A
negative number reflects return reversals. Most of the coefficients in Table 12 are negative,
reflecting a tendency for five-minute price changes to be reversed over subsequent periods.
While many of the autocorrelations changed from the Pre-Pilot to Pilot Period, we focus on how
the pilot sample compares to the control sample. Over one lag, removing price restrictions
makes returns in Listed Stocks more negatively autocorrelated. This is true whether the previous
returns were positive or negative. The effect continues for two lags (ten minutes), but only
following positive returns. Price restrictions have no effect on five-minute return autocorrelation
in Nasdaq NM Stocks.
56 Panel B of Table 11 reports results for 32 different hypothesis tests (eight different thresholds, positive and
negative reversals, Listed and Nadaq samples). Of these 32 tests, only one indicates statistical significance at the
five percent level (negative reversals for Listed Stocks at the 3-standard deviation threshold). Even under the null
hypothesis of no true effect, we would expect any individual test to show a “false positive” at the 5% significance
level approximately 5% of the time. Thus, one significant test statistic out of 32 tests does not constitute a
meaningful rejection of the null hypothesis.
Prepared by the Office of Economic Analysis 50
DRAFT