SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
spreads and positive abnormal stock returns surrounding the initiation of the downtick rule on
October 6, 1931, with no significant changes in trading volume, volatility, or the price impact of
trades. He also finds similar results surrounding the initiation of Rule 10a-1 1938. He concludes
that
[b]ecause the uptick rule no longer constrains shorting as much as it once did, any
liquidity effects are likely to be much more modest than the ones identified in the
1930’s. However, it would not be surprising if repeal of the uptick rule were to
lead to some reduction in individual stock liquidity, particularly in less liquid
stocks. 44
In research sponsored by NASD, McCormick and Reilly (1996) find that the introduction
of the bid test did not have a substantive impact on market quality, as measured by volatility and
bid ask spreads. A more comprehensive follow-up study by McCormick and Zeigler (1997),
which was also sponsored by the NASD, supports the original finding that the implementation of
the bid test had little or no impact on market quality. They find that quoted and effective spreads
were narrower in 1997 than in 1994, but they attribute the changes to a gradual improvement in
market quality over time, and not to the implementation of the bid test. They find no significant
change in quoted spreads as a result of the bid test. While they do find a statistically significant
decline in effective spreads, this is a natural consequence of a rule that forces short sellers to act
as liquidity suppliers rather than liquidity demanders. Because the improvement in effective
spreads is coming at the cost of delayed executions, it does not necessarily signify an
improvement in market quality.
Au-Yeung and Gannon (2003) estimate the joint dynamics of index and index futures
returns in Hong Kong, surrounding the elimination of Hong Kong’s uptick rule on March 25,
1996. Using a multivariate GARCH framework, they find evidence that Hong Kong’s uptick
44 This study was funded by the New York Stock Exchange.
Prepared by the Office of Economic Analysis 21