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Tick Size Constraints, Market Structure, and Liquidity

51 Pages Posted: 24 Nov 2013 Last revised: 18 Mar 2014

Mao Ye

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Chen Yao

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: January 31, 2014

Abstract

We argue that a one-penny minimum tick size for all stocks priced above $1 (SEC rule 612) encourages high-frequency trading and taker/maker–fee markets. We find that non-high frequency traders (non-HFTers) are 2.62 times more likely than HFTers to provide best prices, thereby establishing price priority. The larger relative tick size for low priced stocks, however, constrain non-HFTers from providing better prices and HFTers’ speed advantage helps them establish time priority over non-HFTers. Non-HFTers enter the taker/maker market more frequently than HFTers, because they can bypass tick size constraints by paying a fee to the exchange. The incentive to pay a fee is stronger when relative tick size is high. When stock splits increase relative tick size, liquidity does not improve and volume shifts to the taker/maker market. Our results indicate recent proposals to increase tick size will not improve liquidity. Instead, they will encourage high frequency trading and lead to proliferation of markets that bypass the tick size constraints.

Keywords: price constraints, high-frequency trading, maker/taker fees, liquidity, tick size non-price competition

Suggested Citation

Ye, Mao and Yao, Chen, Tick Size Constraints, Market Structure, and Liquidity (January 31, 2014). Available at SSRN: https://ssrn.com/abstract=2359000 or http://dx.doi.org/10.2139/ssrn.2359000

Mao Ye (Contact Author)

University of Illinois at Urbana-Champaign ( email )

406 Wohlers
1206 South 6th Street
Champaign, IL 61820
United States
2172440474 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Chen Yao

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
Shatin, N.T.
Hong Kong
852 39433215 (Phone)

HOME PAGE: http://sites.google.com/site/chenyaosite/research

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