Discussion of “The competitive effects of US decimalization: Evidence from the US-listed Canadian stocks” by Oppenheimer and Sabherwal

Abstract

Models of market microstructure tell us that a spread is necessary to compensate market makers for order processing costs, inventory risk, and adverse selection. Since entry into market making is relatively easy on the Nasdaq dealer market, and the New York Stock Exchange (NYSE) specialist faces competition from public liquidity suppliers as well as from regional exchanges, competition should at least theoretically lead to spreads that are just large enough to cover these costs. This is, of course, provided that spreads are free to adjust to reflect the economic costs of providing liquidity. However, to economize on negotiation costs between buyers and sellers, equity markets have traditionally stipulated a minimum tick size. A minimum tick size reduces the ability of the spread to adjust downwards, potentially resulting in excess trading costs and excess profits to market makers. 2 While the tick size in US equity markets had remained one-eighth since the founding of the NYSE in 1792, 3 the costs for providing liquidity had come down considerably by the end of the 1990s, both due to technological innovation, improved access to information, and improved liquidity. It was clear that a tick size of one-eighth of a dollar was too large. In 1996, the US Congress issued a mandate