SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
Stocks, suggesting that short selling under the bid test might shorten the duration of upbids,
reflecting the restriction that short sales can only hit upbids.
B. Market Quality
1. Liquidity Measures
Because price restrictions alter how orders transact with each other, they have the
potential to alter traditional measures of liquidity. In particular, the price restrictions will often
keep a short sale from executing against the bid quote. Therefore, we expect the depth at the bid
quote to be lower without price restrictions. If a short sale can not execute against the bid, it
often adds depth to the ask quote, and hence, the depth of the ask might be lower without price
restrictions. Alternatively, a restricted short sale might set a lower ask price and an unrestricted
short sale might exhaust the depth at the bid resulting in a lower bid price. Either way, short sale
price restrictions can result in a narrower quoted bid-ask spread.
While quoted spreads and depths measure the displayed supply of liquidity, the effective
spread measures liquidity actually available to investors. Therefore, an examination of effective
spreads is necessary to understand the effect of price restrictions on liquidity. Because price
restrictions can affect the displayed liquidity, we might also expect them to affect the actual
liquidity as well.
Table 6 shows results on the effect of price restrictions on liquidity. For the pilot sample,
the ask depth decreases for Listed Stocks but increases for Nasdaq NM Stocks. The control
sample experiences an increase in depth at the ask. Comparing the changes reveals that the ask
depth of the pilot stocks decreased relative to the ask depth for the control stocks in both Listed
and Nasdaq NM Stocks. This change is significant for Listed Stocks in both the univariate and
Prepared by the Office of Economic Analysis 40