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Short-Sale Restrictions and Price Clustering: Evidence from SEC Rule 201

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Abstract

We provide a novel test of information-based theories of price clustering by examining trade, order, and the National Best Bid and Offer (NBBO) quote price clustering during periods when information is removed from the market. We use a natural experiment of short-sale restrictions resulting from Securities and Exchange Commission (SEC) Rule 201 to more effectively determine the impact of information on price clustering. We find evidence of increased price clustering for trades, orders, and NBBO prices during short-sale restrictions. Overall, our findings indicate that short-sale restrictions harm the price discovery process and lead to a reduction in market efficiency.

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Notes

  1. We define price clustering as the tendency of trade prices to fall on an ending digit of zero or five.

  2. Odd-lot trades were historically used as a proxy for retail trades. See, for example Lakonishok and Maberly (1990) and Dyl and Maberly (1992).

  3. Securities Exchange Act Release No. 34–61,595 (Feb. 26, 2010), 75 FR 11232 (Mar. 10, 2010).

  4. We further describe SEC Rule 201 restrictions in Section 3.

  5. Increased liquidity or noise trading could be a result of margin calls, portfolio rebalancing, herding behavior, etc. We do not attempt to disentangle the motivation of trades.

  6. Researchers have made similar arguments regarding trading halts. Arak and Cook (1997), for example, find that daily price limits, a type of circuit breaker used in futures markets, provide a stabilizing effect. Thus, our paper contributes to the literature regarding all types of trading disruptions, such as halts or restrictions.

  7. For example, SEC Regulation-SHO was for a specific time period in which specific securities were subject to the NYSE bid price test or NYSE’s uptick rule and NASDAQ’s bid price.

  8. Additionally, Jain et al. (2012) state that the SEC adopted Rule 201 to help prevent potentially manipulative short selling and bear raids in an effort to ensure investor confidence. Jain et al. (2012) indicate that the ultimate regulatory goal was to restrict short selling in only a few securities in an attempt to preserve liquidity and price efficiency-related benefits.

  9. The fixings refer to the practice of the London gold market where firms meet and set a price that clears the market. This occurs twice daily, once in the morning at 10:30 am, and once in the afternoon at 3:00 pm.

  10. Harris defines volatility as the five day standard deviation of a stock price.

  11. The SEC repealed the NYSE and NASDAQ price tests in July 2007.

  12. Following trading halts, Hauser et al. (2006) find that the information dissemination process is 40% faster. However, Madura et al. (2006) find minimal evidence of price discovery after trading halts.

  13. Previous studies document differing levels of clustering by trade size (see Alexander and Peterson 2007; Blau et al. 2012; and Davis et al. 2014). As stated in Davis et al. (2014), there are systematic differences in price levels at various trade sizes.

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Authors and Affiliations

  1. Collat School of Business, University of Alabama at Birmingham, Birmingham, AL, USA

    Ryan L. Davis

  2. School of Business, Dalton State College, Dalton, GA, USA

    Stephen N. Jurich

  3. Mihaylo College of Business and Economics, California State University, Fullerton, CA, USA

    Brian S. Roseman

  4. Cameron School of Business, University of North Carolina Wilmington, 601 South College Road, Wilmington, NC, 28403, USA

    Ethan D. Watson

Authors
  1. Ryan L. Davis
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  2. Stephen N. Jurich
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  3. Brian S. Roseman
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  4. Ethan D. Watson
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Correspondence to Ethan D. Watson.

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Davis, R.L., Jurich, S.N., Roseman, B.S. et al. Short-Sale Restrictions and Price Clustering: Evidence from SEC Rule 201. J Financ Serv Res 54, 345–367 (2018). https://doi.org/10.1007/s10693-017-0272-7

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  • DOI: https://doi.org/10.1007/s10693-017-0272-7

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