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SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

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Reg SHO Pilot Report 2/12/2007<br />

spreads and positive abnormal stock returns surrounding the initiation of the downtick rule on<br />

October 6, 1931, with no significant changes in trading volume, volatility, or the price impact of<br />

trades. He also finds similar results surrounding the initiation of Rule 10a-1 1938. He concludes<br />

that<br />

[b]ecause the uptick rule no longer constrains shorting as much as it once did, any<br />

liquidity effects are likely to be much more modest than the ones identified in the<br />

1930’s. However, it would not be surprising if repeal of the uptick rule were to<br />

lead to some reduction in individual stock liquidity, particularly in less liquid<br />

stocks. 44<br />

In research sponsored by NASD, McCormick and Reilly (1996) find that the introduction<br />

of the bid test did not have a substantive impact on market quality, as measured by volatility and<br />

bid ask spreads. A more comprehensive follow-up study by McCormick and Zeigler (1997),<br />

which was also sponsored by the NASD, supports the original finding that the implementation of<br />

the bid test had little or no impact on market quality. They find that quoted and effective spreads<br />

were narrower in 1997 than in 1994, but they attribute the changes to a gradual improvement in<br />

market quality over time, and not to the implementation of the bid test. They find no significant<br />

change in quoted spreads as a result of the bid test. While they do find a statistically significant<br />

decline in effective spreads, this is a natural consequence of a rule that forces short sellers to act<br />

as liquidity suppliers rather than liquidity demanders. Because the improvement in effective<br />

spreads is coming at the cost of delayed executions, it does not necessarily signify an<br />

improvement in market quality.<br />

Au-Yeung and Gannon (2003) estimate the joint dynamics of index and index futures<br />

returns in Hong Kong, surrounding the elimination of Hong Kong’s uptick rule on March 25,<br />

1996. Using a multivariate GARCH framework, they find evidence that Hong Kong’s uptick<br />

44 This study was funded by the New York Stock Exchange.<br />

Prepared by the Office of Economic Analysis 21

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