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Does the "uptick rule" stabilize the stock market? Insights from Adaptive Rational Equilibrium Dynamics

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  • Fabio Dercole
  • Davide Radi

Abstract

This paper investigates the effects of the "uptick rule" (a short selling regulation formally known as rule 10a-1) by means of a simple stock market model, based on the ARED (adaptive rational equilibrium dynamics) modeling framework, where heterogeneous and adaptive beliefs on the future prices of a risky asset were first shown to be responsible for endogenous price fluctuations. The dynamics of stock prices generated by the model, with and without the uptick-rule restriction, are analyzed by pairing the classical fundamental prediction with beliefs based on both linear and nonlinear technical analyses. The comparison shows a reduction of downward price movements of undervalued shares when the short selling restriction is imposed. This gives evidence that the uptick rule meets its intended objective. However, the effects of the short selling regulation fade when the intensity of choice to switch trading strategies is high. The analysis suggests possible side effects of the regulation on price dynamics.

Suggested Citation

  • Fabio Dercole & Davide Radi, 2014. "Does the "uptick rule" stabilize the stock market? Insights from Adaptive Rational Equilibrium Dynamics," Papers 1405.7747, arXiv.org.
    • Handle: RePEc:arx:papers:1405.7747
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    Cited by:

    1. Sarah Mignot & Fabio Tramontana & Frank Westerhoff, 2021. "Speculative asset price dynamics and wealth taxes," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 641-667, December.
    2. Giovanni Campisi & Silvia Muzzioli & Fabio Tramontana, 2021. "Uncertainty about fundamental, pessimistic and overconfident traders: a piecewise-linear maps approach," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 707-726, December.
    3. in ׳t Veld, Daan, 2016. "Adverse effects of leverage and short-selling constraints in a financial market model with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 45-67.

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