Edwin Hu, Paul Hughes, John Ritter, Patti Vegella, and Hao Zhang

Abstract:

This paper examines the effects of the Tick Size Pilot Plan on average stock market quality. We compare changes in market quality, as measured by spreads, quoted depth, trading volume, volatility, and price efficiency, between the Test and Control Groups. Overall, we find that on average, relative to stocks in the Control Group, market quality deteriorates for stocks in the Test Groups. Specifically, we find that stocks in the Test Groups experience an increase in spreads and volatility and a decrease in price efficiency, relative to stocks in the Control Group. We find that displayed depth at the best quotes increases for all Test Groups. However, when we compare the displayed depth at the best quotes to the total displayed depth within five cents of the best quotes prior to the Pilot, we find that the displayed depth only increases for stocks in the Test Group subject to the trade-at rule. We find that displayed depth within fifteen cents of the best displayed quotes increases for all Test Groups. However, this increase in depth does not appear to lower the transaction costs of large orders, which also increase when the tick size widens. We find that the deterioration in market quality appears to be greater for stocks that had average quoted spreads less than the increased tick size (i.e., less than five cents) during the pre-Pilot period. Our evidence suggests that these findings are mainly driven by the widening of quoting increments as opposed to imposing a trading increment or a trade-at rule, as we only find a few significant differences between the different Test Groups (e.g. the Test Group subject to the trade-at rule).