Choice of Order Size and Price Discovery: The Last Digit Puzzle

Abstract

I claim that uninformed traders prefer ending the size of their orders with a zero (e.g. 110 shares) but it is not the case for informed traders, creating an information channel and providing a signal. I propose the Last Digit Hypothesis (LDH): i) some traders exhibit a last digit preference for the digit 0 and other traders do not while ii) the latter are better able to trade on information than the former. The LDH predicts that a trade arising from a marketable order with a size ending with a 0 on average contributes less to price discovery than other trades. My empirical findings support the LDH. However, the LDH is not an equilibrium since informed traders have an incentive to mimic the preferences of uninformed traders to avoid detection and face little constraints or costs to do so. It is puzzling that I find no evidence of such mimicking. I offer plausible explanations for this finding.

Keywords: price discovery, digit preference, order size, informed trading, market microstructure, regulations

JEL Classification: G02; G10; G14; G15; G18