Clustering in US Stock Prices after Decimalisation

25 Pages Posted: 29 Dec 2007

See all articles by David L. Ikenberry

David L. Ikenberry

Leeds School of Business, University of Colorado Boulder; University of Illinois at Urbana-Champaign - Department of Finance

James Weston

Rice University - Jesse H. Jones Graduate School of Business

Abstract

Early in 2001, US equity markets transitioned from trading in discrete price fractions to a smoother decimal format with a tick size of one penny. Theory suggests in an unconstrained world, stock prices should be distributed uniformly, particularly if the cost of defeating time priority is low. This regime change provides a natural experiment to test whether investors prefer to trade at particular price points even when their choices are essentially unconstrained by regulation. Instead of uniformity, we find widespread evidence of price clustering at increments of five and ten cents (nickels and dimes)' the overall magnitude of clustering is double in scale of what is otherwise expected. Previous studies which documented clustering around even-eighths argued that these patterns were a rational market response to trading impediments. We report consistent findings, but also find that the overall level of post-decimalisation clustering is far more extensive than is reasonably explained by prior hypotheses. The evidence instead suggests a more fundamental human bias for prominent numbers as discussed in the psychology literature. Contrary to previous studies, we find no difference in price clustering, ceteris paribus, between the Nasdaq and NYSE after decimalisation. Should regulators choose to revisit the notion of tick size, our evidence suggests that for many stocks there would be only minor impact between the transaction prices that prevail now and those that would occur if the tick size were increased to five cents.

Suggested Citation

Ikenberry, David L. and Weston, James Peter, Clustering in US Stock Prices after Decimalisation. European Financial Management, Vol. 14, No. 1, pp. 30-54, January 2008. Available at SSRN: https://ssrn.com/abstract=1079200 or http://dx.doi.org/10.1111/j.1468-036X.2007.00410.x

David L. Ikenberry (Contact Author)

Leeds School of Business, University of Colorado Boulder ( email )

Boulder, CO 80309-0419
United States
303-492-1809 (Phone)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
340 Wohlers Hall
Champaign, IL 61820
United States
217-333-6396 (Phone)
217-333-4101 (Fax)

James Peter Weston

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005
United States
713-348-4480 (Phone)
713-348-6331 (Fax)

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