Relative Tick Size and the Trading Environment

Abstract

We investigate how and why relative tick sizes influence traders’ order strategies, and how this affects liquidity provision in the market. Using unique NYSE data, we find that a larger relative tick size benefits high-frequency trading (HFT) market makers: they leave orders in the book longer, trade more aggressively, and have higher profit margins. In a tick-constrained (tick-unconstrained) environment, larger relative ticks result in greater (less) depth, which is consistent with greater adverse selection coming from increased undercutting of limit orders by informed HFT market makers.