The Tick Size Tradeoff: Implications for Optimal Tick Sizes and Causal Inference
63 Pages Posted: 23 Dec 2022 Last revised: 10 Jan 2024
Date Written: December 14, 2022
Abstract
Using the Tick Size Pilot (TSP), we provide new empirical evidence on stock-specific optimal tick sizes. Our method differs from the common practice that treats stocks whose quoted spreads are not constrained by the TSP's 5¢ tick size as a homogeneous population. Using comprehensive depth-of-book data, we show that the TSP harmed market quality for stocks with tight quoted spreads, yet improved it for stocks with wide spreads. When accounted for, this heterogeneity offers guidance for research that uses the TSP to draw causal inference in broader settings. For example, we show that the impacts of larger tick sizes on financial information production are primarily liquidity driven, whereas the extant literature attributes them solely to larger ticks deterring algorithmic trading.
Keywords: Tick size tradeoff, Market quality, Liquidity, Arbitrage, Causal inference
JEL Classification: G14
Suggested Citation: Suggested Citation