Abstract
This paper offers a systematic review of the empirical literature on the implications of tick size changes for exchanges. Our focus is twofold: first, we are concerned with the market quality implications of a change in the minimum tick size. Second, we are interested in the implications of changes in the minimum tick size on market structure. We show that there is a large body of empirical literature that documents a decrease in transaction costs following a decrease in the minimum tick size. However, even though market liquidity increases, the incentive to provide market making activities decreases. We document a strong link between the minimum tick size regulations and the recent increase in high frequency trading activity. A smaller tick enhances the price discovery process. However, the question of how multiple tick size regimes affect market liquidity in a fragmented market remains to be answered. Finally, we identify topics for future research; we discuss the empirical literature on the minimum trade unit and the recent calls for a minimum resting time for quotes.
Highlights
In many respects, and until recently, changes on the minimum tick size regulations appeared to have been fuelling the race to the bottom for transaction costs
The vast majority of the empirical literature has documented a decrease in spreads and an increase in liquidity following a tick size reduction
We document the strong link between the minimum tick size regulations and the recent increase in high frequency trading (HFT)
Summary
Until recently, changes on the minimum tick size regulations appeared to have been fuelling the race to the bottom for transaction costs. This was primarily the case in the US markets since 2001—that is, since the adoption of decimal pricing that slashed costs in terms of a reduction in bid–ask spreads. We present the empirical literature concerned with the effect of minimum tick size regulations on trading costs and liquidity. We document the strong link between the minimum tick size regulations and the recent increase in high frequency trading (HFT). We discuss the implication of the minimum tick size on market volatility
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