SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
indicator variables measure the effect of removing price restrictions. It also helps to control for
any unforeseen differences between the pilot and control stocks.
We run all tests separately for stocks listed on an exchange and stocks listed on Nasdaq
NM because the rule applied to trading of Nasdaq NM Stocks is different than the rule applied to
the trading of stocks listed on exchanges. 48 This allows us to satisfy one purpose of the Pilot,
which is to clearly distinguish the effect of each type of rule.
B. Behavior of Stock Prices Surrounding the Pilot Initiation
In order to evaluate whether the tick test or the bid test affects the level of stock prices,
we examine average daily returns and average cumulative returns for pilot and control stocks
over a 21-day period surrounding the beginning of the pilot. If pilot stocks are over-valued
because of the price restrictions these returns should be significantly negative for pilot stocks
relative to the control stocks on or around the first day of the pilot. Cumulative returns are
normalized to zero on April 29, the trading day prior to the start of the pilot.
We believe it likely that any valuation effects of the pilot that are not already impounded
into the price before the start of the pilot would most likely be observed immediately upon the
initiation of the pilot, and reflected in the returns on the first day. However, we also consider the
possibility that the effects of the pilot might be manifest over a longer time period. Therefore, we
also examine returns over a six month time horizon. To avoid a survivor bias, we compound
returns to the six month horizon if a stock falls out of the sample prior to October 31, 2005. In
addition, to control for the systematic risk of a stock, we estimate an alpha for each stock. We
estimate these alphas in-sample using the market model:
48 It is worth noting that neither the bid test nor tick test applies to the trading of Nasdaq NM stocks on exchanges.
Prepared by the Office of Economic Analysis 29