The Effect of Tick Size on Volatility, Trader Behavior, and Market Quality

37 Pages Posted: 15 Feb 1998

See all articles by Tavy Ronen

Tavy Ronen

Rutgers Business School -Newark and New Brunswick, Department of Finance & Economics

Daniel G. Weaver

Rutgers Business School

Date Written: September 29, 1998

Abstract

We use the American Stock Exchange?s May 1997 market-wide adoption of $1/16 ticks to examine several hypothesis relating to tick size reduction. Specifically, we consider volatility, other aspects of market quality, trader behavior, and specialist profits. The hypothesis that volatility is directly related to tick size is supported by significant decreases in both daily and transitory volatility. Consistent with the hypothesis that market quality improves after the switch, we also find that while bid-ask spreads decline, depths do not. While we find no significant changes in overall specialist profits, we develop a direct test of changes in professional traders? activity in ?stepping ahead of the book?, and find an increase in this behavior, suggesting benefits to market orders through price improvement. Finally, we develop and test a model that shows that stocks with spreads greater than one tick may exhibit significant narrowing of spreads following a tick size reduction. Our results are consistent with the predictions of our model.

Note: This paper appeared previously as "'Teenies' Anyone? The Case of the American Stock Exchange."

JEL Classification: G14, G15, G18

Suggested Citation

Ronen, Tavy and Weaver, Daniel G., The Effect of Tick Size on Volatility, Trader Behavior, and Market Quality (September 29, 1998). Available at SSRN: https://ssrn.com/abstract=59808 or http://dx.doi.org/10.2139/ssrn.59808

Tavy Ronen

Rutgers Business School -Newark and New Brunswick, Department of Finance & Economics ( email )

1 Washington Park
Newark, NJ 07102
United States
973-353-5272 (Phone)

HOME PAGE: http://https://www.business.rutgers.edu/faculty/tavy-ronen

Daniel G. Weaver (Contact Author)

Rutgers Business School ( email )

94 Rockafeller Road
Piscataway, NJ 08854
United States
848.445.5644 (Phone)
732.445.2333 (Fax)

HOME PAGE: http://weaver.rutgers.edu

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