Lot Size Constraints and Market Quality: Evidence from the Borsa Italiana
Financial Management, Vol. 44, Issue 4, pp. 905-945, 2015
67 Pages Posted: 21 Oct 2010 Last revised: 23 Dec 2019
Date Written: June 12, 2015
Trading venues often impose a minimum lot size (minimum trade unit [MTU]) to facilitate order execution. We document changes in market quality associated with the reduction of the MTU to one share on the Italian stock exchange, the Borsa Italiana. We observe a substantial improvement in liquidity, with an average decrease in the relative spread of 10.2%, and more significant improvements for those firms for which the MTU constraint was more binding. We also show that the improvement in liquidity is mainly driven by a reduction in adverse selection; that informational efficiency is not significantly affected; and there is an increase in retail trading. We interpret our findings in light of a model of asymmetric information in which the MTU affects traders’ choice of order size.
Keywords: minimum trade unit constraint, limit order book, market liquidity, adverse selection costs
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