Tick Size Wars: The Market Quality Effects of Pricing Grid Competition

Abstract

We explore the effects of a "tick size war" where European exchanges competed directly on the minimum pricing increment in the limit order book, the tick size. We find exchanges that reduced their tick size immediately captured market shares of quoted and executed volume from exchanges that kept their ticks large. Tick size competition improves market quality, reduces trading costs and increases aggregate depth and volume. These improvements are strongest in stocks where the spread was constrained to one tick, where liquidity providers use the finer pricing grid to engage in price competition.

Keywords: Equity Trading; Limit Order Markets; Tick Sizes

JEL Classification: G10; G20