Subsidizing Liquidity with Wider Ticks: Evidence from the Tick Size Pilot Study

Abstract

Using data from the 2016-2018 tick size pilot study, we examine the efficacy of using wider tick sizes to subsidize market-making in small capitalization stocks. We demonstrate that realized spreads decay quickly within the initial microseconds of a trade. The effect reduces the subsidy offered by wider tick sizes, particularly for non-HFT market makers. The profit subsidy from wider tick sizes is also compromised by a significant shift in trading to “taker/maker” exchanges and to midpoint trading in non-exchange venues. The pilot’s exception for midpoint trades also accounts for the fact that nearly a third of trading remains in non-exchange venues despite the inclusion of a trade-at rule. Overall, these findings point to considerable inefficiencies in the pilot study’s goal of using wider tick sizes to subsidize liquidity provision in small capitalization stocks

Keywords: tick size pilot, high-frequency trading, market making, market structure

JEL Classification: G10, G15, G18, G23, G28, K22