Minimum Tick Size Research Articles

Can splits create market liquidity? Theory and evidence

We present a market microstructure model of stock splits in the presence of minimum tick size rules. The key feature of the model is that discretionary trading is endogenously determined. There exists a tradeoff between adverse selection costs on the one hand and discreteness related costs and opportunity costs of monitoring the market on the other hand. Under certain parameter values, there exists an optimal price. We document an inverse relation between the coefficient of variation of intraday trading volume and the stock price level. This empirical evidence and other existing evidence are consistent with the model.

True Spreads and Equilibrium Prices

ABSTRACTStocks and other financial assets are traded at prices that lie on a fixed grid determined by the minimum tick size. Observed prices and quoted spreads do not correspond to the equilibrium prices and true spreads that would exist in a market with no minimum tick size. Using Monte Carlo Markov Chain methods, this paper estimates the equilibrium prices and true spreads. For large stocks, most of the quoted spread is attributable to the rounding of prices and the adverse selection component is small. The true spread and the adverse selection component are greater for mid‐sized stocks.

Predicting VNET: A model of the dynamics of market depth

The paper proposes a new intraday measure of market liquidity, VNET, which directly measures the depth of the market corresponding to a particular price deterioration. VNET is constructed from the excess volume of buys or sells associated with a price movement. As this measure varies over time, it can be forecast and explained. Using NYSE TORQ data, it is found that market depth varies with volume, transactions, and volatility. These movements are interpreted in terms of the varying proportion of informed traders in an asymmetric information model. When an unbalanced order flow is transacted in a surprisingly short time relative to that expected using the Engle and Russell (Econometrica 66 (1998) 1127) ACD model, the depth is further reduced providing an estimate of the value of patience. The analysis is repeated for 1997 TAQ data revealing that the parameters of the relationships changed only modestly, despite shifts in market volume, volatility, and minimum tick size. A dynamic market reaction curve is estimated with the new data.

Market changes and spread components, implications for international markets

Abstract Trading in international markets is changing and evolving due to competitive pressure and technological innovations. Evidence of changes are seen on the London Stock Exchange, Amsterdam Stock Exchange, the Swiss Exchange, and the Deutsche Borse. This paper examines changes in the components of Nasdaq spreads following the implementation of new Order Handling Rules in early 1997 and the reduction in minimum tick size from $0.125 to $0.0625 in June 1997. Trading volume increases and spreads decrease significantly following each change. We find that order processing and asymmetric information costs decline following each rule change. Inventory holding costs increase over the sample period. Also, we find a significant increase in the probability of a trade flow reversal after the implementation of the Order Handling Rules.

Intra-Day Seasonalities on Stock Returns: Evidence from the Turkish Stock Market

One of the interesting findings among the seasonalities in stock markets is that the return, volume and volatility of the stock prices and bid-ask spreads all broadly follow a U-shaped pattern over the trading day. This study examines the intra-daily seasonalities of the stock returns in the emerging Turkish Stock Market which is an order-driven continuous auction market using electronic trading without market makers in the period from January 1, 1996 through January 15, 1999 by using 15-minute (and also 5 minute and 1 minute) interval data. Results show that stock returns follow a U-shaped or more precisely a W-shaped pattern over the trading day at the Istanbul Stock Exchange (ISE) since there are two trading sessions in a day. This result is consistent with the previous findings in the literature. Opening (Overnight) and closing returns are significantly large and positive. In addition, volatility is higher at the openings and follows an L-shape pattern during the both sessions. Interestingly, the daily average close-to-close returns are generated only during the opening and closing intervals and the average intra-day return is negative when the returns at the opening and/or closing intervals (even the first and the last minutes of the day) are excluded from the analyses. Thus, the rest of the trading day provides no gains (losses) to close-to-close overall returns. Findings suggest that relatively higher closing prices are not corrected by the market at the opening of the next trading day. Relatively higher mean return and standard deviation at the openings of the trading sessions seem to be significantly generated by the accumulated overnight information and the closed-market effect (halt of trade). Mondays have the highest opening mean return and volatility among the days of the week supports this explanation. On the other hand, large day-end returns are strongly affected by the activities of fund managers and speculators who, at the end of the day, boost their portfolios' asset value by bidding higher and accepting ask prices that result to higher closing prices with the contribution of relatively higher minimum tick sizes determined by the Stock Exchange. Intra-day seasonalities that also exist significantly in the Turkish Stock Market, are consistent with those of the international stock markets. This conclusion implies that large profits can be realized by using a simple trading rule, based on the strong intra-day seasonalities in stock returns at the ISE, such as buying and selling stocks at a particular time of the day.

The successful redenomination of a futures contract: The case of the Australian all ordinaries share price index futures contract

This paper examines the economic consequences of the change in the specifications of the Sydney Futures Exchange Share Price Index futures contract that occurred on 11 October 1993. The scale of the contract was changed, while at the same time the minimum tick size was increased. Futures market intervention to change the specifications of a futures contract usually occurs when the contract has not been successful, where successful contracts are defined as contracts which have high volumes of trading. The changes to the SPI futures contract provide a unique opportunity to examine patterns of trading in a liquid futures contract before and after the date of the market intervention. The success or otherwise of market intervention can be viewed from the perspective of the exchange, or of its customers. This paper uses regression analysis to examine the volume of trading in the SPI futures contract before and after 11 October 1993, and concludes that the changes to the specification of the contract can be viewed as successful, for both the exchange members and investors.

Automated Versus Floor Trading: An Analysis of Execution Costs on the Paris and New York Exchanges

A global trend towards automated trading systems raises the important question of whether execution costs are in fact lower than on trading floors. This paper compares the trade execution costs for the common stock of similar firms in an automated trading structure (Paris Bourse) and a floor-based trading structure (NYSE). Results indicate that execution costs are higher in Paris, and the difference is accentuated after the reduction in the minimum tick size on the NYSE in June 1997. Execution costs continue to be higher in Paris (14 basis points) than in New York after controlling for differences in adverse selection, relative tick size, and economic attributes across samples, and the cost differential appears to be economically significant. These results suggest that the present form of the automated trading system may not be able to fully replicate the benefits of human intermediation on a trading floor.

Eighths, sixteenths, and market depth: changes in tick size and liquidity provision on the NYSE

Using limit order data provided by the NYSE, we investigate the impact of reducing the minimum tick size on the liquidity of the market. While both spreads and depths (quoted and on the limit order book) declined after the NYSE's change from eighths to sixteenths, depth declined throughout the entire limit order book as well. The combined effect of smaller spreads and reduced cumulative limit order book depth has made liquidity demanders trading small orders better off; however, traders who submitted larger orders in lower volume stocks did not benefit, especially if those stocks were low priced.

Changing the Size of a Futures Contract: Liquidity and Microstructure Effects

AbstractWe analyze the relation between contract size and liquidity using data from the respecification of Sydney Future Exchange's (SFE) Share Price Index (SPI) and 90‐day Bank Accepted Bill (BAB) futures contracts. Respecification of SPI and BAB contracts presents a unique opportunity to investigate the effects of a change in futures contract size. SFE decreased the size of SPI futures by a factor of four while increasing its minimum tick. The BAB contract was doubled in size with the minimum tick size left unchanged. We find, after controlling for market factors, that the respecification of the SPI futures resulted in higher trading volume, while that of BAB futures decreased trading volume. The results regarding spreads are ambiguous. Based on two cases investigated, we conclude that decreasing the futures contract size was effective in terms of enhancing liquidity while increasing the size resulted in a reduction in liquidity.

LIQUIDITY AND TICK SIZE: DOES DECIMALIZATION MATTER?

AbstractThe effect of the move to decimalization by the Toronto Stock Exchange, where the minimum tick size was decreased to $0.05 from $0.125, is examined. Liquidity is measured by the price impact of unexpected volume. Results show an unambiguous gain to investors. Effective spreads decrease significantly, but the price impact is unaffected. In addition, evidence indicates an increase in trading activity in absolute terms as well in relation to U.S. exchanges for cross‐listed stocks. This is consistent with the observed decrease in transaction costs.

True Spreads and Equilibrium Prices

Stocks and other financial assets are traded at prices that lie on a fixed grid determined by the minimum tick size permitted in the market. Consequently, observed prices and quoted spreads do not correspond to the equilibrium prices and true spreads that would exist in a market with no minimum tick size. This paper models the equilibrium movements of two latent variables: equilibrium price and spread by a bivariate autoregressive process with correlated errors. We estimate the parameters governing their movements using transaction prices and information on quoted bid-ask spreads. Due to the econometric complexities created by the rounding to a discrete grid we use Monte Carlo Markov Chain methods to implement the parameter estimation. The empirical analysis is performed on a selection of large, heavily-traded U.S. stocks. The results indicate that most of the quoted spread is attributable to the rounding of prices and the adverse selection component is small.

Eighths, Sixteenths and Market Depth: Changes in Tick Size and Liquidity Provision on the Nyse

We use limit order data provided by the New York Stock Exchange (NYSE) to investigate the impact of reducing the minimum tick size on the liquidity of the market. Specifically, we analyze both spreads and depths (quoted and on the limit order book) for periods before and after the NYSE's change from eighths to sixteenths. Similar to other studies, we find that quoted spreads and quoted depth declined after the change. However, we find that depth declined throughout the entire limit order book as well. The combined effect of smaller spreads and reduced cumulative depth in the limit order book has made liquidity demanders trading small orders better off while those trading large orders worse off. The benefit to the small order occurs mostly in frequently traded stocks, while small orders in infrequently traded stocks see little, if any, benefit.

Price clustering and bid-ask spreads in international bond futures

We examine price clustering in government bond futures contracts traded at the London International Financial Futures and Options Exchange (LIFFE) and its impact on bid-ask spreads. This open outcry environment provides a rich dataset comprising all quotes and trades, in contrast to data from markets such as the Chicago Mercantile Exchange (CME), which only includes price-change transactions. The German and UK bond futures have low levels of price clustering, and bid-ask spreads are concentrated at the minimum tick size. In contrast, the Italian and Japanese contracts reveal considerably more clustering, and this coincides with wider spreads. We also present evidence on the relationship between the degree of price clustering and trade size.

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.

The Impact of Decimalization on Market Quality: An Empirical Investigation of the Toronto Stock Exchange

I address the “decimalization” debate, i.e., whether trading on cent ticks rather than fractions of a dollar reduces trading costs without diminishing liquidity. I use Toronto Stock Exchange data following their switch to decimal trading on April 15, 1996. For stocks whose minimum tick was reduced from one-eighth of a dollar to five cents, decimalization reduced spreads, while liquidity was not adversely affected. Investors' trading costs and liquidity providers' profits declined on average, but trading volume did not increase. For stocks whose minimum tick size declined from 5 cents to 1 cent, decimalization had little impact on market quality.Journal of Economic LiteratureClassification Numbers: G12, G15

Tick Size and Market Quality

All of the US stock markets have reduced their respective minimum tick sizes. Since the three major US markets, the American Stock Exchange (AMEX), New York Stock Exchange (NYSE), and Nasdaq, all have different order-priority systems, the impact of the tick-size reduction on spread width, as well as other aspects of market quality, can differ across the markets. Given that previous research has established a link between spread width and a firm's cost of capital, this differing impact is important to firms in their exchange listing decision. This study examines changes in market quality across two different priority systems, price-time and price-sharing, following a reduction in the minimum tick size by the Toronto Stock Exchange (TSE) on April 15, 1996. We find that, following the reduction in minimum tick size on the TSE, spreads generally narrow and quoted depths decline for both priority systems. (Depth is defined as the total number of shares offered or sought at a price.) The effect is greatest on low-priced, high-volume stocks.

Reducing tick size on the Stock Exchange of Singapore

Minimum price changes, or tick sizes, are set by exchanges. Using theoretical and empirical models, previous researchers have concluded that transactions costs are increased unnecessarily if tick sizes are set higher than economic fundamentals justify. On July 18, 1994, the Stock Exchange of Singapore reduced the minimum tick size for stocks trading at $25 or more from $0.50 to $0.10. This event provides a unique opportunity to investigate the effects of an actual reduction in minimum tick size. We find that the reduction decreased bid-ask spreads significantly and thereby reduced transactions costs.