When Does the Tick Size Help or Harm Market Quality? Evidence from the Tick Size Pilot

Abstract

Tick sizes provide a market quality tradeoff between pricing fidelity and undercutting. Hence, the same tick size change may affect narrow- and wide-spread stocks in opposite directions. Exploiting the Tick Size Pilot’s imposition and conclusion, we study the thresholds where market-quality effects of a larger tick switch directions. For stocks with two or fewer (fifteen or more) ticks within the bid-ask-spread, reducing (raising) the tick size improves market quality. Our methodology contrasts with existing TSP studies which treat all non-tick constrained stocks the same and our analysis suggests care when using the TSP as an exogenous shock to liquidity.

Keywords: Liquidity, Tick Size, Transaction Costs, Market Microstructure, Price Efficiency

JEL Classification: G14