Minimum Tick Size Research Articles

What Makes HFTs Tick? Tick Size Changes and Information Advantage in a Market with Fast and Slow Traders

We study the impact of two changes in the minimum tick size, a reduction and a subsequent increase, on the trading behavior of fast and slow traders in the spot foreign exchange market. We find that the most notable impact of the tick size reduction is a substantial increase in the liquidity demand of high-frequency traders (HFTs) and not the decrease in their liquidity provision discussed by prior literature. We show that this change in behavior is linked to the higher frequency of price signals that arises with the smaller tick size and to the ability of fast traders to profit from it, often at the detriment of slower traders. Following the tick size decrease and the increase in liquidity demand by HFTs in the spot market, the role of the spot market in price discovery drops relative to that of the futures market. We discuss these findings in the context of the impact of HFTs on the information content of financial markets. This paper was accepted by Agostino Capponi, finance. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2022.02935 .

The lower the better? Revisiting minimum tick size

ABSTRACT We analyse the impact on liquidity of a reduction of the minimum tick size to sub-cent levels at the Vienna Stock Exchange. We find no effect, even after controlling for the extent to which stocks were constrained by the pre-change tick size. Our results imply that regulator-imposed lower bounds on the tick size are not necessarily harmful, and they fail to confirm the existence of a u-shaped relation between tick size and illiquidity as predicted by theoretical models.

The Effects of Changes in Tick Size and Tax Rates on the Tax-Timing Option and the Market Response to Stock Distributions

This study examines how changes in tick size and the differential between short-term and long-term capital gain tax rates affect the market response to the announcement of stock distributions. Prior research finds that a stock distribution increases the volatility of the stock, which in turn increases the value of the stock’s tax-timing option. We show that the minimum tick size established by the exchange where the stock is traded affects a stock’s volatility and, therefore, the value of the tax-timing option and the market response to the stock distribution. We document a stronger relation between the market response and changes in volatility among large distributions than among small distributions. We also find a positive relation between the market response and the tax rate differential, although it is only significant for small distributions. Finally, we show that the relationship between the market response and changes in both volatility and tax rate differential is primarily driven by tax-sensitive institutional investors in the distributing firm.

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.

Stock liquidity and the accrual anomaly

PurposeThis study examines the effect of stock liquidity on the magnitude of the accrual anomaly.Design/methodology/approachThis paper examines the relation—both time-series and cross-sectional—between stock liquidity and the magnitude of the accrual anomaly and use the 2001 minimum tick size decimalization as a quasi-experiment to establish causality.FindingsThere is both cross-sectional and time-series evidence that stock liquidity is negatively related to the magnitude of the accrual anomaly. Moreover, the extent to which investors overestimate the persistence of accruals decreases with stock liquidity. Results from a difference-in-differences analysis conducted using the 2001 minimum tick size decimalization as a quasi-experiment suggest that the effect of stock liquidity on the accrual anomaly is causal. The findings of this study are consistent with the enhancing effect of stock liquidity on pricing efficiency.Originality/valueThe study's findings are well aligned with the mispricing-based explanation for the accrual anomaly, suggesting that the improvement in market-wide stock liquidity drives the contemporaneous decline in the magnitude of the accrual anomaly, at least to a great extent.

The anatomy of a fee change — evidence from cryptocurrency markets

We analyze the impact on liquidity and trading activity of the introduction of maker fees (and simultaneous reduction of taker fees) on a leading cryptocurrency trading platform. Cryptocurrency markets are special because they are non-intermediated and highly fragmented. Furthermore, for the currency pair we analyze (BTC–USD) the relative minimum tick size is negligible, a feature which allows us to derive predictions from the Colliard and Foucault (2012) model which assumes a zero minimum tick size. Consistent with the model we find that quoted spreads increase after the fee change. However, the increase is overcompensated by the decrease in taker fees. Quoted depth and the number of transactions decrease while the average trade size increases.

Does stock market liquidity affect dividends?

Using two exogenous shocks, we examine the causal impact of stock liquidity on firms' dividend policy. Both the first shock, the reduction of the minimum tick size from 1/16 to decimals in the US, and the second shock, the mandatory conversion of non-traded stocks to traded stocks in China, changed the liquidity of affected stocks. We find, in both experiments, that increased stocks liquidity results in a significant reduction in dividends. Our empirical design enables us to control for asset liquidity, investment changes, and other omitted factors that might affect firms' dividend policy. We conclude that when firms set dividend policies, satisfying investors' liquidity needs is a significant factor.

Does the bid–ask spread affect trading in exchange operated dark pools? Evidence from a natural experiment

We exploit exogenous reductions in the minimum tick size to examine the effect of the bid–ask spread in the lit market on dark trading activity in the exchange operated dark pool in Japan. Stocks affected by the minimum tick size experience a decline in the share of trading in the exchange operated dark pool. The decrease in the share of dark trading is mostly evident among stocks with a constrained tick size prior to the tick size changes. Overall, our findings imply that reducing the minimum tick size can help lit venues regain market shares over dark venues.

US experience with futures transaction taxes

AbstractThe transaction tax on futures reduced trading volume during the 1920s and 1930s but had no apparent effect on volatility or open interest. The relative magnitude of the tax was highest for intermediaries and appears to have substantially reduced intra‐day trading, but it did not dramatically affect hedging activity or the level of cash or futures prices. Pit traders were particularly distressed by a 400% increase in the tax rate in 1932 and effectively widened spreads by avoiding trades at the minimum price increment. This doubling of the minimum tick size was formally implemented in exchange rules 1 year later.

Minimum tick size and analyst coverage: Evidence from the Tick Size Pilot Program

AbstractWe examine whether an exogenous increase in the minimum tick size created by the natural experiment, the Tick Size Pilot Program, impacts analyst coverage. Proponents of the Tick Size Pilot Program argue that increasing the minimum tick size would increase analysts’ incentives to cover these firms (the promotion effect). In contrast, indirect evidence from prior research suggests that increasing the tick size might lead to decreased analyst coverage due to lower trading volume (the liquidity effect). Surprisingly, evidence on whether changes in tick size impact analyst coverage is absent from the literature. Using a difference‐in‐differences research design, we find that analyst coverage declined for tick‐constrained NYSE/AMEX stocks that experienced the strictest increase in minimum tick size trading rules. We find no change in analyst coverage for NASDAQ stocks, relative to the control sample. This finding is robust to several cross‐sectional tests and even within samples where we expect the promotion effect is strong. Overall, our results indicate that the regulatory activism surrounding the increase in the minimum tick size is likely misplaced, as we find no evidence to support the claims that increasing the minimum tick size increases analyst coverage for small cap stocks.

True Liquidity and Fundamental Prices: US Tick Size Pilot

We develop a big-data methodology to estimate fundamental prices and true liquidity measures, explicitly considering the rounding specification due to the minimum tick size. Evaluation of the tick size pilot (TSP), which increased the tick size for some randomly chosen stocks, requires the impact of rounding. Our true liquidity measures capture the TSP-driven decreased inventory costs of market-makers, whereas traditional measures without the rounding adjustment cannot. We nd that the TSP increases market-maker pro ts, but does not improve liquidity and price efficiency. This result contrasts existing empirical studies but is consistent with recent theoretical studies that account for rounding.

Minimum Tick Size and Analyst Coverage: Evidence from the Tick Size Pilot Program

We examine whether an exogenous increase in the minimum tick size created by the natural experiment, the Tick Size Pilot Program, impacts analyst coverage. Proponents of the Tick Size Pilot Program argue that increasing the minimum tick size would increase analysts’ incentives to cover these firms (the promotion effect). In contrast, indirect evidence from prior research suggests that increasing the tick size might lead to decreased analyst coverage due to lower trading volume (the liquidity effect). Surprisingly, evidence on whether changes in tick size impact analyst coverage is absent from the literature. Using a difference-in-differences research design, we find that analyst coverage declined for tick-constrained NYSE/AMEX stocks that experienced the strictest increase in minimum tick size trading rules. We find no change in analyst coverage for NASDAQ stocks, relative to the control sample. This finding is robust to several cross-sectional tests and even within samples where we expect the promotion effect is strong. Overall, our results indicate that the regulatory activism surrounding the increase in the minimum tick size is likely misplaced, as we find no evidence to support the claims that increasing the minimum tick size increases analyst coverage for small cap stocks.

Price discovery, order submission, and tick size during preopen period

Using limit order book data, this study investigates the effects of minimum tick size reduction on price discovery and order submission strategies during the preopen call auction period in the Tokyo Stock Exchange. Studying the largest stocks' changes before and after the tick size reduction, our findings suggest that price discovery becomes more efficient when a smaller tick size is employed. A reduction in tick size induces a decrease in market depth and spread and enhances the speed of price discovery by encouraging more aggressive order to be placed and providing investors a better learning and communicating environment to incorporate information into order decisions. Our results demonstrate that, although orders are not matched and no transaction occurs during the preopen period, the order placement at these moments is neither necessarily noisy nor completely manipulative; factors that impact the investor's order choice during the normal trading period also work in this period.

Tick size and market quality: Simulations based on agent‐based artificial stock markets

SummaryThis paper investigates the way that minimum tick size affects market quality based on an agent‐based artificial stock market. Our results indicate that stepwise and combination systems can promote market quality in certain aspects, compared with a uniform system. A minimal combination system performed the best to improve market quality. This is the first study to analyse tick size systems that remain at the theory stage and compare four types of system under the same experimental environment. The results suggests that a minimal combination system could be considered a new direction for market policy reform to improve market quality.

Stock market illiquidity, bargaining power and the cost of borrowing

Abstract We show that firms with illiquid stock have higher syndicated loan spreads. This result is invariant to measurement of stock illiquidity, and is robust to a wide set of cross-sectional loan and firm features, firm and time fixed effects. It also holds using a matched difference-in-differences estimator, at an exogenous reduction in the minimum tick size of major United States exchanges, and using a two-stage least squares estimator. Stock illiquidity is shown to increase spreads more when a lead lender has a high market share or a borrower has a low credit rating. It increases spreads less when a borrower has public rated debt and it diminishes the benefit to the loan recipient of a lending relationship. Measurements of stock price informativeness and firm-level governance do not affect the stock illiquidity and loan spread relation. A rationale for these findings is that stock illiquidity impairs the bargaining power of corporate borrowers, in negotiating a loan rate, as it raises the cost of alternatively raising funds by issuing equity.

Modelling asset returns under price limits with mixture of truncated Gaussian distribution

ABSTRACT In this paper, we propose to use the mixture of truncated Gaussian distribution in modelling the financial asset return distribution under price limits. Theoretically, while retaining many convenient statistical properties of the Gaussian distribution, the proposed model assumes a flexible structure accommodating some important special features of the return data under price restrictions, such as the clusters near the bounds (due to the ‘bound effect’) and peaked shape around zero (due to the minimum-tick size effect). It can also allow for a wide range of variances and kurtosis even with a bounded domain. These are the salient features that the conventional models (such as the Normal, Truncated Normal and Censored Normal) do not have. For empirical illustration, we apply our proposed model to stocks under different price restrictions. Some common interesting features have been found. Furthermore, in our Value-at-Risk analysis, we find that ignoring the bound cluster in the tail of the distribution could lead to a significant overestimation of the number of violations and produce unreliable Value-at-Risk measures. In addition, we also find that the proposed model has a better empirical performance when the data are highly asymmetric and heavy-tailed.

The Tradeoff between Discrete Pricing and Discrete Quantities: Evidence from U.S.-listed Firms

Economists usually assume that price and quantity are continuous variables, while most market designs, in reality, impose discrete tick and lot sizes. We study a firm’s trade-off between these two discretenesses in U.S. stock exchanges, which mandate a one-cent minimum tick size and a 100-share minimum lot size. A uniform tick size favors high prices because the bid–ask spread cannot be lower than one cent. A uniform lot size favors low prices because low prices reduce adverse selection costs for market makers when they have to display at least 100 shares. We predict that a firm achieves its optimal price when its bid–ask spread is two ticks wide, when the marginal contribution from discrete prices equals that from discrete lots. Empirically, we find that stock splits improve liquidity when they move the bid–ask spread towards two ticks; otherwise, they reduce liquidity. Liquidity improvements contribute 95 bps to the average total return on a split announcement of 272 bps. Optimal pricing can increase the median U.S. stock value by 69 bps and total U.S. market capitalization by $54.9 billion.

Limit order submission risks, order choice, and tick size

We propose empirical measures of non-execution and picking-off risks and demonstrate that a minimum tick size reduction decreases non-execution risk but increases picking-off risk on the Tokyo Stock Exchange. This results in a higher tendency to submit aggressive orders for some stocks and cancel limit orders for the others. We conclude that our two limit order submission risks are crucial for understanding the results of past empirical studies that examine how minimum tick size reduction impacts limit order submission risks and why traders become aggressive in their order choice. We further show that our proposed measures of non-execution and picking-off risks are better variables than are proxies for the two risks such as spread (which have been suggested by previous empirical studies) or transaction cost measured by the relative tick size when analyzing the determination of the order choice and/or evaluating a minimum tick size reduction policy.

Does Bid-Ask Spread Affect Trading in Exchange Operated Dark Pool? – Evidence From a Natural Experiment

We exploit the exogenously instituted minimum tick size change to examine the dynamic relationship between the bid-ask spread in the lit market and dark trading activity in the exchange operated dark pool in Japan. Using a difference – in – differences methodology, we document a significant treatment effect where stocks that are affected by the minimum tick size change have a lower share of trading in the exchange operated dark pool. Overall, our empirical findings provide first-hand evidence that a significant amount of dark trading is liquidity seeking. Reducing minimum tick size can help lit venues regain market shares over dark venues.

The Impacts of Minimum Trading Units and Tick Size Changes on Bid-ask Spread, Depth, and Trading Volume: Evidence from the Indonesia Stock Exchange

Purpose – This research aims to analyze the differences in the bid-ask spread, depth, and trading volume after a new tick size and minimum trading unit policy were imposed by the Indonesian Stock Exchange (IDX) on January the 6th, 2014. Design/Methodology/Approach – This research is exercised on the three variables of liquidity, i.e. the bid-ask spread, the depth, and the trading volume. This research used a paired difference test to measure the impact before and after the policy was imposed. Findings – The results showed that the smaller the tick size, the greater the average decrease of the bid-ask spread, ask depth, and bid depth, but the trading volume did not show a significant average difference. Research Implications – The tick size reduction was consistent and supported the previous research from different countries. The bid-ask spread, ask depth, and bid depth significantly decreased, and the trading volume had a tendency to increase as well, although it was not significant. Results are aimed at the IDX and Bapepam as additional information related to the changes that occurred as a result of the implementation of the new policy in stock trading. Investors can use the information from this study to make investment decisions.