Tick Size and Price Reversal after Order Imbalance

Espen Sirnes,Minh Thi Hong Dinh

doi:10.3390/ijfs9020019

Abstract

It is well known that intraday returns tend to reverse the following intraday period, conditional on excess buying pressure on the bid or ask side. This suggests that liquidity providers “overreact” to order imbalance (OIB) by initially altering quotes so much that a negative autocorrelation is seen in mid-price returns. We investigate under which circumstances this behavior is most common. Specifically, it seems the tick size augments “OIB-reversal”. However, if the tick size is binding for much of the trading day, it has the opposite effect of censoring such reversals. In addition, if market liquidity is high, the reversal becomes more frequent.

Highlights

Chordia et al (2005) found that NYSE specialists tend to adjust their quotes in the opposite direction of arriving trades
We test the effect of market factors such as spread, tick size, number of trades, volatility, and frequency at which the stick size is binding on the order imbalance (OIB) reversal
The results show that LNRelTickSize, consistently for all models, is significantly positively associated with OIB reversal

Summary

Introduction

Chordia et al (2005) found that NYSE specialists tend to adjust their quotes in the opposite direction of arriving trades. This causes a significant negative autocorrelation in returns, conditional on the difference between buyer and seller-initiated trades. This difference is called order imbalance (OIB), and we refer to the tendency that prices tend to reverse conditional on this as the OIB-reversal effect. The main contribution of this paper is an improved understanding of how the tick size interacts with liquidity provision and OIB. This, in turn, leads to a negative autocorrelation conditioned on order imbalance (OIB-reversal)

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