True Liquidity and Fundamental Prices: US Tick Size Pilot

96 Pages Posted: 1 Apr 2021 Last revised: 31 Aug 2023

See all articles by Rohit Allena

Rohit Allena

C.T. Bauer College of Business, University of Houston

Tarun Chordia

Emory University - Department of Finance

Date Written: March 31, 2021

Abstract

We develop a big-data methodology to estimate true stock prices and liquidity, explicitly considering rounding due to the minimum tick size. We apply our method to evaluate the tick size pilot (TSP), which increased the tick size for randomly chosen stocks. While the TSP increases market-maker profits, it does not improve liquidity. This is consistent with theoretical models but contrasts with existing empirical studies. Rounding-adjusted liquidity measures are validated by showing that they, unlike the existing liquidity measures, capture the TSP-induced trading restrictions, the decreased inventory holdings of market-makers, and exhibit less dispersion across exchanges. Accounting for rounding is important.

Keywords: True Liquidity, Fundamental Prices, True bid-ask spreads, US Tick Size Pilot, Machine Learning for Structural Estimation, Variational Inference, High-Frequency Data, Scalable Algorithms

JEL Classification: G14, G15, G18, C11, C55

Suggested Citation

Allena, Rohit and Chordia, Tarun, True Liquidity and Fundamental Prices: US Tick Size Pilot (March 31, 2021). Available at SSRN: https://ssrn.com/abstract=3816411 or http://dx.doi.org/10.2139/ssrn.3816411

Rohit Allena (Contact Author)

C.T. Bauer College of Business, University of Houston ( email )

Houston, TX 77204
United States

Tarun Chordia

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-1620 (Phone)
404-727-5238 (Fax)

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