اثر تست قیمت بر رفتار معامله گران و کیفیت بازار: تجزیه و تحلیل Reg SHO

Using data from Regulation SHO's pilot program, we examine how price tests affect trader behavior and market quality, which are areas of interest given by the US Securities and Exchange Commission in evaluating these tests. After comparing sampled matched pairs of pilot and control stocks, we find that the removal of price tests benefit traders by allowing them to trade more aggressively by placing orders that receive quicker execution. Furthermore, concerns about the suspension of price tests leading to a degradation of market quality are unfounded. The evidence therefore suggests unambiguously that such tests should be removed.

In this paper we use recently published data from a pilot program under the US Securities and Exchange Commission's (SEC) Regulation SHO (Reg SHO) in order to evaluate the effects of price tests on trader behavior and market quality on the New York Stock Exchange (NYSE) and Nasdaq. These tests apply to short sales and are known individually as the uptick rule on the NYSE and the bid test on Nasdaq. 1 The SEC had three objectives in mind when it introduced the tests: “(i) allowing relatively unrestricted short selling in an advancing market; (ii) preventing short selling at successively lower prices, thus eliminating short selling as a tool for driving the market down; and (iii) preventing short sellers from accelerating a declining market by exhausting all remaining bids at one price level, causing successively lower prices to be established by long sellers” ( SEC, 2004a, pp. 50–51). More simply, the SEC sought to prevent short sellers from participating in market manipulation that forces prices downward, often referred to as bear raids. 2 The pilot program temporarily suspends price tests for a subset of the stocks that are members of the Russell 3000 index, referred to hereafter as pilot stocks. The stated motivation for the suspension was to allow an examination of “the extent to which a price test is necessary to further the objectives of short sale regulation [and] to study the effects of relatively unrestricted short selling on market volatility, price efficiency, and liquidity” and “to monitor trading behavior” ( SEC, 2004a, pp. 4, 12; SEC, 2004b, p. 2). Ultimately, such examinations could lead the SEC to either amend or remove price tests. In this paper we examine how price tests affect trader behavior and market quality as measured by market volatility, price efficiency, and liquidity.3 We do not examine whether price tests further the stated objective of short sale regulation as this was done previously by Alexander and Peterson (1999) who had the benefit of having order data (such data are not publicly available under Reg SHO). Importantly, their study shows that, relative to similar regular sell orders, short sell orders: (1) take longer to execute, (2) are more frequently cancelled or not filled, and (3) if not executed immediately, frequently become part or all of the inside ask, thereby leading to narrower quoted spreads and greater depth at the ask relative to the bid. Interestingly, the uptick rule was found to impede short selling in an advancing market, thereby failing to achieve the first objective of the rule. Using Reg SHO data for the NYSE, we find that the costs associated with delays in execution due to the uptick rule come with the benefit of price improvement. More specifically, we find that executed short sales of pilot stocks relative to a matched sample of control stocks have lower price locations (i.e., trade prices) relative to the quotes. 4 This is expected since market and marketable limit orders (i.e., limit sell orders with limit prices equal to or less than the bid) of pilot stocks are now more likely to be executed immediately instead of being held up by the uptick rule for possible future execution. Consistent with this observation, we also find that pilot stock short sales that execute below the midpoint have greater price impact, indicating that they contribute more to price discovery when the rule is suspended. Thus, the removal of price tests for all NYSE stocks will give traders increased freedom to choose how aggressively they want their orders executed since market and marketable limit orders will no longer be treated as de facto limit orders with limit prices above the bid. Furthermore, even quote-improving and at-the-quote limit orders are likely to receive quicker execution since Alexander and Peterson (1999) show that such orders receive slower execution than similar regular sell orders when the uptick rule is in place. Additional NYSE analysis reveals that, relative to control stocks, the pilot stocks have similar quoted and effective spreads but significantly (1) smaller short trade sizes, (2) more short trades, (3) more short volume, and (4) smaller ask depths. The differences with regard to trade size and number of trades are consistent with an increase in “order splitting” by large informed short sellers of pilot stocks after the removal of the uptick rule as a means of disguising their intentions (Boehmer, Jones and Zhang, 2007). As a follow-up to the examination of the impact of the uptick rule on effective spreads and depths, we observe a significant increase in the frequency of short orders that are executed below the midpoint for the pilot stocks after the rule is suspended. In contrast, control stocks have more short trades that execute above the spread midpoint and are often equivalent to at-the-quote or quote-improving limit orders. As a result, the typical bid/ask depth ratio is higher after the removal of the uptick rule. Hence, price tests should be viewed as a hindrance to execution that, by delaying execution, distort liquidity.5 Further evidence that short selling does not, on balance, hurt liquidity is provided by noting that short trades execute at prices that are, on average, above the quote midpoint even when the uptick rule is suspended, albeit by a smaller amount. Hence, the typical trade involving a short sale is buyer initiated in the sense of Lee and Ready (1991). Lastly, we do not find any evidence that the rule has resulted in pilot stocks having either increased price volatility or decreased price efficiency. Thus, from the evidence regarding volatility, efficiency, and liquidity, we believe that market quality on the NYSE has not been degraded by the suspension of the uptick rule. With regard to Nasdaq, a previous study by Ferri, Cristophe and Angel (2004) indicates that the bid test has little effect on the execution of short orders. Furthermore, in a June 15, 2006 filing with the SEC (Federal Register, June 22, 2006, p. 35965), the National Association of Securities Dealers (NASD) notes that “several exchanges that trade Nasdaq securities do so with no short sale regulation, encouraging market participants to route short sale orders to their markets to avoid any regulatory restriction” Thus, it is not surprising that our analysis of short trades on Nasdaq indicates that the bid test is relatively inconsequential. More specifically, most differences are notably smaller and less frequently significant than those found for the pilot stocks listed on the NYSE. Hence, we believe that the suspension of the bid test has not materially changed trader behavior or degraded market quality on Nasdaq. Lastly, we also examine those matched pairs where either the pilot or control stock is in the lowest 20% of the Russell 3000 by market capitalization and analyze them during the days in the pre- and post-periods when the Russell 2000 declined in value by at least 1%. The motivation for this analysis is to see if small stocks react differently from the overall sample during periods of market stress.6 However, since no substantive differences were observed, we conclude that the removal of price tests has had no deleterious effect on trader behavior and has not led to a decrease in market quality as measured by liquidity, price efficiency, or market volatility. The evidence therefore suggests unambiguously that such tests should be removed. The remainder of the paper is organized as follows. Section 2 reviews the literature and Section 3 provides a description of the data and sample. Section 4 presents empirical analysis of trader behavior, and Section 5 continues the empirical analysis be examining various measures of market quality. Section 6 presents the conclusion.

HO that temporarily suspends price tests for some stocks to examine how the tests affect (1) trader behavior and (2) market quality, which are areas of interest given by the SEC in deciding whether to permanently remove or amend these tests. After comparing a sample of matched pairs of pilot and control stocks, we conclude that the removal of price tests has had no deleterious effect on trader behavior and has not led to a decrease in market quality. More specifically, we find that suspension of the uptick rule on the NYSE leads traders to place more executable short orders that are of smaller size. The resulting trades are typically executed at lower prices relative to the quotes, and have slightly greater price impact. All of these results are consistent with an increase after the removal of price tests in ‘‘order splitting’’ by informed large short sellers of pilot stocks who seek to disguise their intentions as suggested by Boehmer, Jones, and Zhang (2007). We also find significant declines in the ask depth occurring after price tests are removed on the NYSE and, consequently, an increase in the bid/ask depth ratio. Furthermore, the significant decrease in execution price after the removal of the uptick rule on pilot stocks can be attributed to an increased ability to trade more aggressively since short market or marketable limit orders can be executed immediately if they do not exceed the quoted bid depth. In contrast, stocks that trade with the uptick rule in place are traded less aggressively since they tend to execute above the bid more frequently and are often equivalent to de facto quote-improving or at-the-quote limit orders. Thus, the removal of price tests will give traders increased freedom to choose how quickly they want their orders to be executed. Evidence that short selling without price tests does not, on balance, hurt liquidity is provided by noting that short trades on the NYSE execute at prices that are, on average, above the quote midpoint even after the suspension of price tests, albeit by a smaller amount. Thus, price tests should be viewed as a hindrance to execution that, by removing immediacy, distorts liquidity. Similar results are observed for Nasdaq pilot stocks except that the differences in the number of short trades, short trade size, and bid/ask ratios are no longer significant. Furthermore, the effect on ask depths, execution prices, and price impacts are notably smaller. Thus, Nasdaq’s bid test seems to be relatively inconsequential, a result that is hardly surprising since some exchanges do not enforce the bid test when trading Nasdaq-listed stocks. As for other measures of market quality, we find no evidence of a significant change in either market volatility or market efficiency after the suspension of price tests on either the NYSE or Nasdaq. These findings are somewhat surprising, given the significant increase in the price impact of short trades that execute below the midpoint after the tests are suspended. However, this could be due to the fact that the increased impact is too subtle since (1) roughly 27% (40%) of the NYSE (Nasdaq) trades analyzed involve a short sale with less than half of them executing below the midpoint and (2) the average price impact of such short sales is only 4.72 (0.77) basis points higher on the NYSE (Nasdaq) when the tests are removed.35 Importantly, the economic implications of these findings are that removal of price tests are not expected to lead to changes in the equity premium, nor such things as option pricing or the cost of capital. Concern was expressed at the SEC’s Roundtable on Reg SHO that price tests might be most beneficial for small cap stocks during times of market stress. However, replication of all our tests using only the days of greatest market stress (defined as the days when returns on the Russell 2000 dropped at least 1% in value) with just the small cap pilot and control stock pairs does not alter any of the conclusions reached with the full sample on all days. In sum, the removal of price tests has had no deleterious effect on trader behavior and has not led to a decrease in market quality as measured by liquidity, price efficiency, or market volatility. The evidence therefore suggests unambiguously that such tests should be removed.