Larger Tick Size Research Articles

Does better liquidity for large orders attract institutional investors and analysts? Evidence from the Tick Size Pilot Program

Based on the SEC's Tick Size Pilot Program, we adopt a difference-in-differences design and find that the improved liquidity for large orders increases their ownership of the treatment firms with a larger tick size during the program. The effect is concentrated among firms with lower liquidity for large orders ex ante and mainly comes from dedicated investors and quasi-indexers. We also find that analyst coverage and forecast accuracy increase for the treatment firms, plausibly catering to the increased information demand of institutional investors. Consequently, price efficiency increases as well. Overall, we show the bright side of this controversial program.

Minimum tick size, market quality and costs of trade execution in Vietnam.

The Vietnamese government introduced a change in the minimum tick size for stock trading on 12 September 2016 to improve market quality and reduce trade execution costs. The intended effects of this policy have not been widely investigated in an emerging market such as Vietnam. We use data on trade and quote intraday of all stocks listed on the Ho Chi Minh Stock Exchange for the periods before and after the event, with a one-week break from 12/9/2016 to 18/9/2016, for the market to adapt to the new tick size policy. Findings from this paper confirm that the trading cost is reduced following the change to the smallest tick size. However, this is different for large trades executed at the stock price associated with a larger tick size. Furthermore, the findings are robust with a different sample period. These findings imply that introducing a change in tick size in Vietnam in 2016 is desirable for improving market quality. However, the differentiation of these changes in different ranges of stock prices is not necessarily effective for improving market quality and reducing trade execution costs.

Why Do Stock Exchanges Compete on Speed, and How?

This paper shows that a key driver of stock exchanges' competition on order-processing speeds is the Order Protection Rule, which requires an exchange to route its customers' orders to other exchanges with better prices. Faster exchanges attract more price-improving limit orders because the probability of being bypassed by trades with inferior prices on other exchanges is reduced. When all exchanges speed up, this probability can increase, potentially harming the welfare of investors. In contrast, increasing connection speeds between exchanges raises investor welfare by reducing this probability. Nevertheless, no exchange wants to improve connection speeds because this will reduce its trading volume. I provide empirical evidence showing that slow exchanges lose trading volume to fast exchanges as the latter attract more price-improving orders. I first show that a slow exchange's (IEX) market share of trading volume in stocks with a five-cent tick, the minimum price movement, increases by 13 percent relative to one-cent tick stocks after the introduction of Tick Size Pilot Program in 2016, because price improving is less likely with larger tick size. I then show that after switching from a dark pool to a public exchange, IEX attracts more trading volume in stocks that are more likely to have one tick bid-ask spread as price improving is impossible with binding spread.

Who Provides Liquidity and When: An Analysis of Price vs. Speed Competition on Liquidity and Welfare

I model the interaction between buy-side algorithmic traders (BATs) and high-frequency traders (HFTs). When the minimum price variation (tick size) is small, BATs dominate liquidity provision by establishing price priority over HFTs in the limit order book (LOB), because providing liquidity is less costly than demanding liquidity from HFTs. A large tick size, however, constrains price competition and encourages HFTs to provide liquidity by establishing time priority. An increase in adverse selection risk raises the unconstrained bid-ask spread, reduces tick size constraints, and discourages HFTs’ liquidity provision. An increase in tick size increases transaction costs and harms liquidity demanders, but it does not benefit liquidity providers because the costs of speed investments dissipate the rents resulting from the tick size. I predict that mini-flash crashes are more likely to occur for stocks with a smaller tick size and higher adverse selection risk. I suggest that the literature should not use the message-to-trade ratio as a cross-sectional proxy for HFTs’ liquidity provision because stocks with more liquidity provided by HFTs have a lower message-to-trade ratio.

The Effect of Tick Size on Trading Volume Share in Two Competing Stock Markets

The relationship between tick sizes and trading volume shares in competing markets is studied theoretically. By introducing a simple model which is equipped with two markets and non-strategic traders, we analytically calculate the steady states. It is shown that a market with a larger tick size is generally deprived of its share by the competing market. However, if traders’ preference for the present market because of its major share is strong enough, the market with a larger tick size has a chance to keep a major share in the steady state. These findings are consistent with the previous results obtained from a more complicated artificial market model and also provide a clear understanding of the basic mechanism of market competition.

The Ex-dividend Day Behaviour of REITs: Tax or Market Microstructure Effects

We examine the importance of the tax and microstructure theories in explaining the ex-dividend day behaviour of US REIT stock prices in three tick size regimes − the 1/8th, 1/16th, and decimal eras. We present a new theory that shows how the tax and microstructure effects interact to produce the observed ex-dividend day behaviour. Our theory also shows why in an era of a large tick size, as in the 1/8th era, the tax effects fail to get detected and the observed ex-dividend day behaviour could be misinterpreted as resulting solely from the microstructure effects.

Two-Sided Markets, Make-Take Fees and Competition between Stock Exchanges

This paper argues that the one-cent tick size imposed by SEC rule 612 is a driving force in the fragmentation of U.S. stock markets. U.S. stock exchanges compete for order flow by setting make fees for liquidity makers and take fees for liquidity takers. When traders can quote a continuous price, the breakdown of the make-take fees is neutralized and order flow consolidates to the exchange with the lowest total fee. However, under a discrete tick size, the breakdown of the maketake fees cannot be neutralized, which results in two-sided markets. The tick size constraints create an incentive for a monopoly operator to establish multiple exchanges for second-degree price discrimination. It also causes competition between two identical exchanges that precludes a zerofee, zero-profit Bertrand outcome but reach mixed-strategy equilibria, with both earning positive profits. This prediction justifies a diversity of fee structures and frequent fee adjustments as well as the entry of exchanges with new fee structures. We show that fees can Pareto improve social welfare under tick size constraints. Our model predicts that markets become more fragmented under a larger tick size. We find empirical evidence consistent with this prediction using splits/reverse splits of ETFs as exogenous shocks to the relative tick size, with paired ETFs that track the same index but do not split/reverse split as controls.

Impacts of stock splits on transaction costs under different tick size regimes

This study determines the impacts of stock splits on transaction costs under tick sizes of $1/16 and $0.01. Similar to previous studies, stock splits decrease quoted dollar spreads and effective dollar spreads, and they increase quoted percentage spreads and effective percentage spreads. The effect of stock splits, however, differs depending on tick size. Quoted percentage spreads increase 44% with the smaller tick size ($0.01), but increase 56% with the larger tick size ($1/16). Moreover, effective percentage spreads increase 39% with the smaller tick size, but increase 44% with the larger tick size. In addition, under the $1/16 tick size regime stock splits increase quoted depth, but under the $0.01 tick size regime stock splits decrease quoted depth.

An evolutionary multi-objective optimization of trading rules in call markets

SUMMARY We evaluate an agent-based model featuring near-zero-intelligence traders operating in a call market with a wide range of trading rules governing the determination of prices and which orders are executed, as well as a range of parameters regarding market intervention by market makers and the presence of informed traders. We optimize these trading rules using a multi-objective population-based incremental learning algorithm seeking to maximize the trading volume and minimize the bid–ask spread. Our results suggest that markets should choose a small tick size if concerns about the bid–ask spread are dominating and a large tick size if maximizing trading volume is the main aim. We also find that unless concerns about trading volume dominate, time priority is the optimal priority rule. Copyright © 2011 John Wiley & Sons, Ltd.

Analysis of Limit Order Book and Order Flow

This paper extensively employs the order and trade data to analyze the shape of limit order book and the behavior of strategic order submission. The order book of stocks exhibits weakly convex pattern on the bid side due to wide price spreads away from the market. This characteristic of liquidity is particularly strong for the small stocks with large minimum tick size. In addition, the same order type occurs more frequently after the event had occurred than it would unconditionally. This diagonal effect is not fully explained by the order splitting. Moreover, the determinants driving order aggressiveness include bid-ask spread, market depths, other price spreads and depths away from the market, and market sentiment. Responding to the limit order book movement, an order aggressiveness revision behavior of market order traders is opposite to limit order traders, and contrarian traders react stronger than momentum traders.

Determining the optimal market structure using near-zero intelligence traders

We evaluate an agent-based model featuring near-zero-intelligence traders operating in a call market with a wide range of trading rules governing the determination of prices, which orders are executed as well as a range of parameters regarding market intervention by specialists and the presence of informed traders. We optimize these trading rules using a population-based incremental learning algorithm seeking to maximize the trading volume. Our results suggest markets should choose a large tick size and ensure only a small fraction of traders are informed about the order book. The effect of trading rules regarding the determination of prices, priority rules, and specialist intervention, we find to have an ambiguous effect on the outcome.

Price resolution in an emerging market: Evidence from the Istanbul Stock Exchange

This study examines price resolution an emerging market that uses a very large relative tick size. Intraday transaction data from the Istanbul Stock Exchange are used to provide evidence concerning clustering when prices change and when they do not change. The results show that in this one-tick market there exists little if any clustering. The clustering that does exist primarily arises from sequential transactions at the same price. The observed positive relation between clustering associated with price changes and uncertainty occurs in periods of high uncertainty during which multiple-tick spreads and price changes are observed.

A Simple Estimate of Noise and Its Determinant in a Call Auction Market

This paper proposes a simple method to decompose the variance of returns into noise and information components, while allowing the two components to be correlated. Economically, noise is the real friction or transaction costs discussed in the literature. To apply the method, this paper examines noise in the Taiwan Stock Exchange, which is a call auction market. It also studies the cross-sectional and time-series variation of noise. The results find that noise has a distinct diurnal effect: the transaction price is less noisy at the open, but is noisier near the close. Trading mechanisms can also affect noise: a larger relative tick size and a longer time interval will increase noise. We also find that individual investors help to reduce noise.

The information content of the limit order book: evidence from NYSE specialist trading decisions

Specialists compete with limit order traders to provide liquidity at the New York Stock Exchange. Since specialists see all system limit orders, they enjoy a unique advantage in this competition. We examine whether the limit order book is informative about future price changes and whether specialists use this information when trading. We use order quantities as well as option values to capture the information content of the limit order book. Our analyses consider three actions specialists can take when a market order arrives: stop the order, immediately fill the order at the quoted price, or immediately fill the order at an improved price. Using SuperDOT limit orders in the TORQ database, we find that the limit order book is informative about future price movements. We also find that specialists use this information in ways that favor them (and sometimes the floor community) over the limit order traders. The results are more evident for active stocks where the competition between specialists and limit order traders is more intense. Moreover, we find strong evidence that specialists in lower-priced stocks are less likely to initiate such actions because of the large relative tick size.

The impact of tick size on intraday stock price behavior: evidence from the Taiwan Stock Exchange

This research examines the impact of tick size on intraday stock price behavior for stocks listed on the Taiwan Stock Exchange over the 2-year period of 1998–1999. The sample involves the same 80 firms that trade under the tick size of (New Taiwan Dollars) NT$0.1 and NT$0.5, respectively. The sample firms display a U-shaped intraday pattern of bid–ask spread, volatility, autocorrelation, and trading volume. The empirical results indicate that a larger tick size is associated with a wider bid–ask spread, larger volatility, and more negative autocorrelation. Moreover, a larger tick size is associated with a higher percentage increase of bid–ask spread and volatility in the middle of the trading period. Finally, the effect of tick size on trading volume is insignificant.

Analysis of Limit Order Book and Order Flow

This paper extensively employs the order and trade data to analyze the shape of limit order book and the behavior of strategic order submission. The order book of stocks exhibits weakly convex pattern on the bid side due to wide price spreads away from the market. This characteristic of liquidity is particularly strong for the small stocks with large minimum tick size. In addition, the same order type occurs more frequently after the event had occurred than it would unconditionally. This diagonal effect is not fully explained by the order splitting. Moreover, the determinants driving order aggressiveness include bid-ask spread, market depths, other price spreads and depths away from the market, and market sentiment. Responding to the limit order book movement, an order aggressiveness revision behavior of market order traders is opposite to limit order traders, and contrarian traders react stronger than momentum traders.

Discrete Prices and Competition in a Dealer Market

The goal of this paper is to investigate the relation between price discreteness and competition in a dealer market, and to study their impact on the welfare of different market participants (dealers and investors). We present a model featuring a finite number of dealers competing in prices for supplying liquidity to a forthcoming market order. Our main result is that there exists an interaction between price discreteness and competition. When competition is lax, dealers prefer fine price grids (small tick size), while when competition is intense they prefer coarse price grids (large tick size). When competition is lax, investors' attitude towards the tick size is ambiguous with some preference towards larger ticks. When competition among dealers is intense, investors prefer fine price grids. The rate of convergence of welfare measures towards perfect competition becomes slower, as the grid of prices becomes finer. This means that the smaller is the tick size, the larger is the number of dealers required to assure a close to competitive outcome. Our results regarding low levels of competition among dealers stand in contrast to the standard view and conventional wisdom, that refining the grid of prices is always beneficial for investors. Our analysis shows that when deciding on the correct tick size for a specific stock, market designers should take into account the level of competition among dealers for this stock.

Is It Time to Split the S&P 500 Futures Contract?

By October 1996, the value of the S&P 500 Index futures contract had grown to five times its value at its inception in April 1982. One way to make the contract more accessible to small investors and to smooth out trading is to split the contract. Splitting the contract could increase transaction costs, although competition would probably limit the amount of the increase. Less clear is the need for increasing the minimum percentage tick size. The current minimum tick size is small for S&P 500 futures compared with that of other futures and also common stocks. The larger tick size could affect volume, however, by increasing trading costs and reducing the willingness to trade.

Tick Size, Share Prices, and Stock Splits

ABSTRACTMinimum price variation rules help explain why stock prices vary substantially across countries, and other curiosities of share prices. Companies tend to split their stock so that the institutionally mandated minimum tick size is optimal relative to the stock price. A large relative tick size provides an incentive for dealers to make markets and for investors to provide liquidity by placing limit orders, despite its placing a high floor on the quoted bid‐ask spread. A simple model suggests that idiosyncratic risk, firm size, and visibility of the firm affect the optimal relative tick size and thus the share price.

Tick Size, Share Prices, and Stock Splits

Minimum price variation rules help explain why stock prices vary substantially across countries, and other curiosities of share prices. Companies tend to split their stock so that the institutionally mandated minimum tick size is optimal relative to the stock price. A large relative tick size provides an incentive for dealers to make markets and for investors to provide liquidity by placing limit orders, despite its placing a high floor on the quoted bid-ask spread. A simple model suggests that idiosyncratic risk, firm size, and visibility of the firm affect the optimal relative tick size and thus the share price.