SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
lower volatility for stocks with higher market capitalization, and higher volatility for
stocks with lower market capitalization.
• Based on the price reaction to the initiation of the pilot, we find limited evidence that
the tick test distorts stock prices—on the day the pilot went into effect, Listed Stocks
in the pilot sample underperformed Listed Stocks in the control sample by
approximately 24 basis points. However, the pilot and control stocks had similar
returns over the first six months of the pilot.
• We find no evidence of “bear raids” associated with the pilot. More specifically, we
test for evidence of bear raids in three ways:
o We test whether the pilot has affected the relative frequency of large negative
vs. large positive stock returns, as reflected in the skewness of the returns
distribution. There is no difference in skewness between control and pilot
stocks
o A bear raid may be associated with a large negative return that is very quickly
reversed, or a “negative price spike.” Although we do find a higher incidence
of negative price spikes in the pilot sample at some horizons, the same thing is
observed for positive price spikes.
o We also measure directly the tendency for price movements to be reversed in
subsequent periods. Again, we find that the pilot is associated with a slightly
greater tendency for price changes to be reversed, but this effect is observed
equally for positive and negative returns.
In summary, having examined the impact of the Regulation SHO Pilot on a wide array of
market characteristics, we conclude that price restrictions constitute an economically relevant
constraint on short selling. Our evidence suggests that removing price restrictions for the pilot
stocks has had an effect on the mechanics of short selling, order routing decisions, displayed
depth, and intraday volatility, but on balance has not had a deleterious impact on market quality
or liquidity. In various dimensions, our evidence confirms that the tick test of Rule 10a-1 acts as
a more binding constraint than the bid test of former NASD Rule 3350. On most dimensions, the
effects of the pilot do not appear to be systematically related to market capitalization or trading
volume, suggesting that our results give a reasonable picture of what we might expect to see if
price restrictions were removed for all stocks, including smaller stocks and stocks less actively
Prepared by the Office of Economic Analysis 56