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Relative Tick Size and the Trading Environment

45 Pages Posted: 9 Jul 2014 Last revised: 30 Jul 2015

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Gideon Saar

Cornell University - Samuel Curtis Johnson Graduate School of Management

Zhuo Zhong

University of Melbourne - Department of Finance

Date Written: July 27, 2015

Abstract

This paper examines how the relative tick size influences market liquidity and the biodiversity of trader interactions. Using unique NYSE order-level data, we find that a larger relative tick size benefits High-Frequency Trading (HFT) firms that make markets on the NYSE: they leave orders in the book longer, trade more aggressively, and have higher profit margins. The effects of a larger relative tick size on the market are more complex. In a one-tick spread environment, a larger relative tick size results in greater depth and more volume; in a multi-tick environment, the opposite outcome prevails. The negative impact on depth and volume in the multi-tick environment is consistent with greater adverse selection coming from increased undercutting of limit orders by informed HFT market makers. Our work suggests why a one-size-fits-all spread policy is unlikely to be optimal, and we propose an alternative policy.

Keywords: tick size, capital formation, liquidity, high-frequency trading, HFT, market makers, exchanges, market microstructure, financial regulation, SEC

JEL Classification: G10, G18

Suggested Citation

O'Hara, Maureen and Saar, Gideon and Zhong, Zhuo, Relative Tick Size and the Trading Environment (July 27, 2015). Available at SSRN: https://ssrn.com/abstract=2463360 or http://dx.doi.org/10.2139/ssrn.2463360

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

Gideon Saar (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

431 Sage Hall
Ithaca, NY 14853
United States
607-255-7484 (Phone)
607-255-5993 (Fax)

HOME PAGE: https://www.johnson.cornell.edu/Faculty-And-Research/Profile?id=gs25

Zhuo Zhong

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

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