Order Submission, Information Asymmetry, and Tick Size

Abstract

Our study investigates traders’ order submission strategies with varying market conditions under information asymmetry. It examines how a reduction in tick size affects informed traders’ order choices in response to changes in market conditions and subsequently influences the information content of the limit order book on the Tokyo Stock Exchange. We quantify the permanent price impact of orders with different levels of aggressiveness to measure the information content of different kinds of orders before and after a reduction in tick size. The results show that market orders and limit orders placed within or at the best bid and offer (BBO) are more informative than limit orders placed behind the BBO. Moreover, when the quoted spread is wider (narrower) and volatility is low (high), the information content of limit orders placed within or at the BBO is larger (smaller) than market orders, providing evidence that informed traders’ order choice on market orders or aggressive limit orders is a trade-off between transaction costs and adverse selection costs. We further observe that the information content increases in market orders but decreases in limit orders placed within or at the BBO when the quoted spread becomes narrower and volatility changes from low to high after tick size reduction. This suggests that informed traders tend to shift from aggressive limit orders to market orders as transaction costs decrease and adverse selection costs increase, transactions become more informative, which reduces the information content of the limit order book.

Keywords: Order submissions, information asymmetry, Tick size reduction, Market conditions, Market microstructure, Tokyo Stock Exchange