Endogenous Changes in the Minimum Tick: An Analysis of Nasdaq Securities Trading Near Ten Dollars

Abstract

This study evaluates changes in trade execution costs and liquidity for a set of 773 Nasdaq-listed stocks whose tick size changed as their share prices passed through $10 during 1995. This analysis allows for a substantially larger effective sample size as compared to before-versus-after studies of market-wide tick size reductions, since stocks experience tick size changes on different dates. It also allows for separate examination of tick size increases and decreases. Full sample results indicate moderately (five to ten percent) lower average trade execution costs with the smaller tick size, and no deterioration in measures of liquidity. The small average effect on trading costs reflects that the tick size does not directly constrain spread widths for the majority of sample firms. Notably, the largest reductions in trading costs occur for a set of firms whose market makers avoid odd-eighth quotations and quote spreads that average fifty to sixty cents. This result is consistent with models implying that the tick size can affect equilibrium bid-ask spreads in a dealer market, even when the equilibrium spread is larger than the tick size.