One size fits all? High frequency trading, tick size changes and the implications for exchanges: market quality and market structure considerations

Abstract

This paper offers a systematic review of the empirical literature on the implications of tick size changes for exchanges. Our focus is twofold: first, we are concerned with the market quality implications of a change in the minimum tick size. Second, we are interested in the implications of changes in the minimum tick size on market structure. We show that there is a large body of empirical literature that documents a decrease in transaction costs following a decrease in the minimum tick size. However, even though market liquidity increases, the incentive to provide market making activities decreases. We document a strong link between the minimum tick size regulations and the recent increase in high frequency trading activity. A smaller tick enhances the price discovery process. However, the question of how multiple tick size regimes affect market liquidity in a fragmented market remains to be answered. Finally, we identify topics for future research; we discuss the empirical literature on the minimum trade unit and the recent calls for a minimum resting time for quotes.

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

“…The most widely used indicators are bid-ask spread, trade volume, and market depth. Tick size is positively correlated with bidask spread, which is the consensus in the vast majority of the empirical literature (Ahn et al, 1996(Ahn et al, , 1998Bollen & Whaley, 1998;Gerace, Smark, & Freestone, 2012;Harris, 1994;Verousis et al 2018). Harris (1994) explained this relation using the concept of real quoted spread.…”

“…Given that market depth indicates an inverse relationship with bid-ask spread and trade volume (Harris, 1994;Chordia & Subrahmanyam, 1995;Hsieh, Chuang, & Lin, 2008;Alampieski & Lepone, 2009;Verousis et al, 2018), it is expected to be positively related to tick size. Goldstein and Kavajecz (2000) and Niemeyer and Sandas (1994) They present that the impact of widening tick size on market depth is determined by whether the bid-ask spread of the stock is larger than the tick size in the market.…”

Effects of MiFID II on Stock Price Formation

“…Anderson and Peng (2014); Bacidore (1997); Ronen and Weaver (2001)). See Verousis et al (2018) for a very recent and exhaustive review of the literature on tick sizes. Most of the existing literature on this subject is relatively old (before the rise of high frequency trading) and/or based on level-1 data (i.e.…”

Tick Size Wars, High Frequency Trading, and Market Quality

“…For recent surveys of the voluminous empirical and theoretical academic literatures on the role of tick sizes in equity markets, seeHolden, Jacobsen, and Subrahmanyam (2013), U.S. Securities and Exchange Commision (2012) andVerousis, Perotti, and Sermpinis (2017).…”