SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
V Methods
A. Comparing Pilot and Control Stocks
We derive the results in this report using several empirical approaches. The first
approach compares the pilot sample to the control sample both before and after the start of the
pilot. The approach allows us to apply a standard t-test to the difference of the differences. As
long as the pilot and control samples are generally well constructed, this approach will control
for changes in market conditions that are unrelated to the pilot. However, this approach may not
fully control for differences within the samples. Further, it is cumbersome when examining the
differential effect of the pilot on sub-samples. Therefore, we will also employ a regression
approach.
The regression approach includes multiple test variables at the same time and also
controls for unforeseen differences between the pilot and control samples. Because the number
of stocks changes over the sample period, we employ daily cross-sectional regressions for each
sample day after the start of the pilot and then we average the coefficients. We employ
variations on the following regression:
Market Quality = α + β Pilot + β Pre Pilot Market Quality
(1)
i 1 i 2
i
where Market Quality is one of several dependent variables (e.g., effective spread) measured for
each stock on one trading day, Pilot is equal to one for pilot stocks and zero for other stocks, and
Pre-Pilot Market Quality is the average daily level of the dependent variable measured over the
Pre-Pilot Period. If the dependent variable is generally larger for pilot stocks than control stocks,
then β1 will greater than zero. If this relation is persistent across time, then the average β1 will be
greater than zero. The Pre-Pilot Market Quality variable helps ensure that the coefficients on the
Prepared by the Office of Economic Analysis 28