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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 />

indicator variables measure the effect of removing price restrictions. It also helps to control for<br />

any unforeseen differences between the pilot and control stocks.<br />

We run all tests separately for stocks listed on an exchange and stocks listed on Nasdaq<br />

NM because the rule applied to trading of Nasdaq NM Stocks is different than the rule applied to<br />

the trading of stocks listed on exchanges. 48 This allows us to satisfy one purpose of the Pilot,<br />

which is to clearly distinguish the effect of each type of rule.<br />

B. Behavior of Stock Prices Surrounding the Pilot Initiation<br />

In order to evaluate whether the tick test or the bid test affects the level of stock prices,<br />

we examine average daily returns and average cumulative returns for pilot and control stocks<br />

over a 21-day period surrounding the beginning of the pilot. If pilot stocks are over-valued<br />

because of the price restrictions these returns should be significantly negative for pilot stocks<br />

relative to the control stocks on or around the first day of the pilot. Cumulative returns are<br />

normalized to zero on April 29, the trading day prior to the start of the pilot.<br />

We believe it likely that any valuation effects of the pilot that are not already impounded<br />

into the price before the start of the pilot would most likely be observed immediately upon the<br />

initiation of the pilot, and reflected in the returns on the first day. However, we also consider the<br />

possibility that the effects of the pilot might be manifest over a longer time period. Therefore, we<br />

also examine returns over a six month time horizon. To avoid a survivor bias, we compound<br />

returns to the six month horizon if a stock falls out of the sample prior to October 31, 2005. In<br />

addition, to control for the systematic risk of a stock, we estimate an alpha for each stock. We<br />

estimate these alphas in-sample using the market model:<br />

48 It is worth noting that neither the bid test nor tick test applies to the trading of Nasdaq NM stocks on exchanges.<br />

Prepared by the Office of Economic Analysis 29

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