Barclay, Michael J.

English

Cornell Law Library

Cornell Law Review
Volume 74
Issue 5 July 1989 Article 2
Comment on Macey Mitchell and Netter
Michael J. Barclay
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Recommended Citation
Michael J. Barclay, Comment on Macey Mitchell and Netter , 74 Cornell L. Rev. 836 (1989)
Available at: http://scholarship.law.cornell.edu/clr/vol74/iss5/2
COMMENT ON MACEY, MITCHELL & NETTER
MichaelJ. Barclay t
Whenever I listen to discussions of trading restrictions such as
short sale restrictions or circuit breakers or other kinds of trading
restrictions that have been proposed, I cannot help being reminded
of the following analogy. Suppose in his opening remarks this
morning Jack told us that he was worried about panics that some-
times occur when fires break out in crowded buildings. So in order
to prevent a potential panic from occurring here today, at the first
sign of smoke he would run over and lock the door. Well you can
imagine what would happen in this room the first time his face
started to twitch or if he made any facial expression that even re-
motely resembled sniffing. Even more important than this short-run
effect, however, is the effect this new fire policy would have on us in
the long term. We would all be a bit less anxious to come and sit in
this room. Returns to a given activity would now have to be a lot
higher before we would be willing to partake because the costs are
now higher. For example, some seminars we otherwise would have
gone to and benefitted from we would pass up.
You may think that this analogy is a bit too extreme to be rele-
vant to a discussion of short-sale restrictions. But, I would like to
argue that the historical precedent clearly indicates that the propen-
sity for panic is much greater among financial market regulators
than it is among financial market participants. My favorite example
illustrating this point goes back to World War I. In the summer of
1914 there was, as we have already discussed, some concern about
the performance of U.S. securities markets. In particular, since
many U.S. financial institutions were holding a considerable amount
of European securities, the regulators were concerned about a pos-
sible spillover effect from the war in Europe to the United States. In
response to this concern, the Federal Reserve Board halted trading
on the New York Stock Exchange in July of 1914. This response
may not seem too extreme until you realize that it was not until al-
most five months later, in December of 1914, that the Federal Re-
serve Board decided to re-open the Exchange. We had five months
in 1914 during which no trading was allowed on the New York Stock
Exchange. Of course, the Federal Reserve Board couldn't halt trad-
ing; all they were able to accomplish in this case was to move the
t Assistant Professor of Business Administration, University of Rochester.
836
1989] COMMENT ON MACEY, MITCHELL & NETTER
location of trading from the floor of the Exchange out onto the
street. And, as it turns out from all accounts of that year, the Fed's
fear of panic in U.S. securities markets was unfounded. If you went
out on the street to trade securities in early December of 1914, the
price level was virtually the same as it was back in July when trading
was halted.
Given this admittedly strong bias on my part towards a pre-
sumption that the appropriate role of governmental regulation in
securities markets is to enforce contracts and to facilitate trade, not
to encumber it, it should not be too surprising that I liked the paper
by Macey, Mitchell, and Netter that was presented this morning, if
for no other reason than that I think they got the right answer. On a
more fundamental level, however, even though I do not think there
is very much new analysis or new evidence in this paper, Macey,
Mitchell, and Netter have done a very nice job of outlining the ex-
isting evidence in a perspective that facilitates discussion and aids in
the policy analysis. In my comments this morning, I would like to
focus on a fairly narrow aspect of those arguments. In particular, I
would like to focus on the argument that unencumbered trading is
important if private information is going to be revealed through
trading, or if market prices are going to be an efficient mechanism
for aggregating and disseminating that private information.
Whether or not you ultimately believe that that is an important issue
rests fundamentally on the empirical question of the importance of
securities markets in aggregating and disseminating private infor-
mation. If this is an important role of the market, if in fact many
stock price movements are caused by the revelation of private infor-
mation and not public information, then any restrictions on trade
that encumber the normal flow of information pose a potentially se-
rious concern that we should deal with.
I would like to approach this problem by giving you the results
of some research that I have conducted with Bob Litzenberger at
Wharton and Jerry Warner at the University of Rochester.' If you
look at a normal weekday in the United States, about 80 percent of
the 24 hour stock return variance occurs during the six daytime
hours that the Exchange is open. In other words most of the action
on the Exchange and most of the stock price changes occur between
10:00 in the morning and 4:00 in the afternoon. There are a couple
of explanations that are consistent with this observation. One ex-
planation rests on the simple observation that companies are much
more likely to release public information at 2:00 in the afternoon
than at 2:00 in the morning. Since the flow of public information is
1 Barclay, Litzenberger & Warner, Private Information, Trading Volume and Stock Re-
turn Variances, REV. FIN. STUDIES (forthcoming).
837
CORNELL LA W REVIEW
expected to be greater during normal trading hours than during
non-trading hours, a higher trading time return variance alone is
not sufficient to distinguish between the effects of increased public
information or the effects of private information revealed through
trading. Luckily, I think, the Tokyo Stock Exchange, provides a
unique experiment for differentiating between the public versus pri-
vate information hypotheses.
The Tokyo Stock Exchange is open for half a day of trading
approximately two Saturdays per month and closed on other Satur-
days. So, for example, in the current period the Tokyo Stock Ex-
change is closed on the second and third Saturday of each month
and open on other Saturdays. Now, many Japanese businesses are
open on Saturdays. However, Saturday is not a normal business day
in Japan, and there is very little public information released on a
Saturday. Regardless of the quantity of public information released,
however, there is no evidence that the flow of public information is
any different on a trading Saturday than on a non-trading Saturday.
Thus, over weekends with and without Saturday trading, the aver-
age flow of public information is held relatively constant while the
volume of trade varies substantially. By observing the behavior of
stock prices on weekends with and without Saturday trading it is
possible to differentiate between the effects of public information
and the effects of private information revealed through trading on
stock return variance.
As it turns out, the variance of stock returns from Friday close
to Monday close, the weekend return variance, is roughly 60 percent
higher on weekends when the Exchange is open on Saturday than
on weekends when the Exchange is closed on Saturday. This vari-
ance increase corresponds surprisingly close to the increase in trad-
ing volume. For example, remember that when the Exchange is
open on a Saturday, it is open for half a normal trading day. In
addition, the trading volume on Saturdays when the Exchange is
open is about 60 percent of the volume on a normal trading day.
Thus, over weekends during which there is Saturday trading, we ob-
serve an increase in trading volume equal to roughly 60 percent of
one day's trading volume, and an increase in the weekend return
variance of about 60 percent. This finding indicates that, holding
the flow of public information constant, there is a close association
between trading volume and stock return variances and it suggests
that a significant fraction of stock price changes result from private
information revealed through trading.
Now in most recent discussions of stock price volatility, there
has been a popular perception that volatility is somehow bad. Thus,
if this were the end of the story, I would be a little apprehensive
838 [Vol. 74:836
1989] COMMENT ON MACEY, MITCHELL & NETTER
about telling it to our security market regulators. But, this is not the
end of the story. You get a much more interesting view of the total
picture if you start to widen the observation window a little bit.
What happens, for example, if instead of looking just at the weekend
variance, you look at the variance from Thursday to Tuesday or the
weekly variance from Wednesday to Wednesday? As you widen this
window, two very interesting events occur. First you observe that
the extra volume that occurs on Saturday is not really new trading
volume; it is simply existing volume that is drawn in from the sur-
rounding days. If the Exchange is open on Saturday, there is more
trading volume on Saturday than when the Exchange is closed. But,
there is also a little less trading volume on the surrounding Thurs-
day, Friday, Monday, and Tuesday. Opening the Exchange on Sat-
urday does not increase the total number of trades; it simply
rearranges them in time. Second, if you look at the weekly variance,
say from Wednesday to Wednesday, there is no evidence that this
weekly variance is higher for weeks when the Exchange is open on
Saturday than for weeks when the Exchange is closed on Saturday.
By opening the Exchange on Saturday, no new business has been
created; there is no more trading than there otherwise would have
been in that week. There is also no additional stock return variance;
the weekly variance is no larger for weeks with Saturday trading than
for weeks with no Saturday trading. But, because there is now trad-
ing on Saturday, some of the information that otherwise would have
been revealed on Monday or Tuesday is now revealed on Saturday.
The absolute price changes we observe are larger over the weekend
but smaller on the subsequent days.
These results are actually quite consistent with several recent
models of markets with heterogeneously informed traders. For ex-
ample, Albert Kyle models a market with three types of traders: in-
formed investors who trade strategically to maximize the profits
from their private information, random liquidity traders whose buy
and sell orders arrive randomly through time, and a specialist who
has no private information, but who learns through price and vol-
ume changes. 2 In this model, private information is incorporated
into prices over time at a constant rate (per trading hour), with the
price at the end of the relevant trading interval reflecting all private
information. The variance of returns over the entire trading interval
reflects only the arrival rate of new information. The variance
within the trading interval, however, also reflects the volume of
trade by random liquidity traders. Trades of both informed and li-
quidity traders move prices since uninformed traders who learn
2 Kyle, Continuous Auctions and Insider Trading, 53 ECONOMETRICA 135 (1985).
839
CORNELL LA W REVIEW
from price and volume changes cannot distinguish between the two.
Thus, trading noise-variance in excess of that generated in a fully
revealing rational expectations model-arises endogenously in this
model because price movements and associated volumes are noisy
signals for the information of informed traders. This trading noise
is rational since the price established by the specialist is an unbiased
estimate of the true price conditional on his information set, and the
trading noise does not result in pricing errors that are systematically
reversed.
Although Kyle does not estimate the specific effects of changing
the Exchange trading hours, his analysis suggests that opening the
Exchange on Saturday will not change the variance of weekly re-
turns as long as the total amount of new public and private informa-
tion is unaltered. Within the week, however, a change in the pattern
of daily variances would be expected, reflecting the effects of the
new trading hours on the arrival of traders. If the total weekly vol-
ume of liquidity trades is unchanged, but the intraweek distribution
is spread evenly over the extended trading hours, then the return
variance will be larger during weekends when the Exchange is open
on Saturday because of the increased volume of both informed and
liquidity traders during this interval. Variance should be lower on
surrounding days because of the lower trading volume and the re-
sulting reduction in the amount of information revealed by in-
formed traders. This is precisely the result that we confirm in our
analysis. This research suggests that the market plays an important
role as a mechanism for aggregating and disseminating private in-
formation. Any efforts by financial market regulators that seriously
encumber trading will potentially diminish this important role of the
market.
I personally think that the uptick rule, as has been suggested
here, is relatively impotent. If you go to the floor of the Exchange
and attempt to short sell some stock, for the typical New York Stock
Exchange firm you will not have to wait very long for an uptick in
order to execute your trade. Thus, in the realm of rules and regula-
tions that we can imagine in effect, I would say that the uptick rule is
one of the less fearsome. On the other hand, I think that current
lobbying and current efforts to strengthen this rule and to extend it
to other markets such as the futures markets or options markets
could be more pernicious. I realize it is probably politically infeasi-
ble to eliminate the uptick rule as it stands, but certainly let's try not
to let it go any further.
840 [Vol. 74:836


Comment on Macey Mitchell and Netter

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