Does The Uptick Rule Inflate Stock Prices?

Abstract

Does the uptick rule inflate stock prices? Miller (1977) hypothesizes that short sale constraints lead to stock overvaluation. In this paper I test this hypothesis in a power setting in which the Security and Exchange Commission (SEC) suspended the uptick rule for a pre-chosen set of stocks (pilot stocks) in 2005. The results suggest that on the NYSE the suspension of the uptick rule mitigates stock overvaluation and brings stock prices closer to their fundamental values. On the NASDAQ, however, lifting the uptick rule goes beyond correcting stock overvaluation; it leads to stock undervaluation. The results are robust after controlling for other factors, such as firm size, book-to-market ratio, stock return momentum, and availability of exchange-traded-options.