The effect of price tests on trader behavior and market quality: An analysis of 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.