Abstract
We examined the effect of reduced tick size on spread and its various components on Taiwan Stock Exchange (TWSE). The TWSE stands for a representative order-driving call mechanism in the emerging market. The noticeable market features of the TWSE render our findings on the effect of tick-size changes useful in combination with those reported in studies on developed markets. Our evidence strongly indicated that the traded spread and the order-processing component declined after tick size was reduced, whereas the asymmetric information component exhibited less significant changes. We documented a relatively high proportion of the order-processing component of the TWSE compared with that observed in developed markets after tick size was reduced. The cross-sectional regression analysis results indicated that stocks with high binding constraints, a high price, and high trading activity generated substantial savings on the order-processing component after tick-size conversion. Our empirical results highlight the important contributions of reduced tick size on market efficiency specifically in an emerging call market setting.
Highlights
The asset exchange process inevitably entails spreads consisting of transaction costs paid by market participants and economic rents charged by liquidity providers
Gibson et al (2003) determined that the reduced traded spread in the NYSE can be primarily attributed to the significant decline in the order-processing component, whereas the asymmetric information component remained essentially unchanged
Ahn et al (2007) discovered that the transitory order processing costs and the permanent asymmetric information costs in the Tokyo Stock Exchange (TSE) significantly declined after tick size was reduced
Summary
The asset exchange process inevitably entails spreads consisting of transaction costs paid by market participants and economic rents charged by liquidity providers. Gibson et al (2003) suggested that reduced spreads caused by converting decimal pricing on NYSE-listed S&P 500 stocks have resulted in a significant decline in the residual order-processing component and less substantial changes in the inventory combined with asymmetric-information component. Among the various spread decomposition models, we employed that developed by George, Kaul, and Nimalendran (GKN, 1991), which was derived from the serial covariance properties of observed transaction prices; and the models presented by Huang and Stoll (HS, 1997) and Madhavan, Richardson, and Roomans (MRR, 1997), both of which were based on trade initiation indicator variables and their related proxies They decomposed total spreads into permanent components, including information asymmetry costs and transitory components, in addition to order-processing costs and inventory-holding costs.
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