Tick size and stock returns

Journal article

Tick size is an important aspect of the micro-structural level organization of financial markets. It is the smallest institutionally allowed price increment, has a direct bearing on the bid–ask spread, influences the strategy of trading order placement in electronic markets, affects the price formation mechanism, and appears to be related to the long-term memory of volatility clustering. In this paper we investigate the impact of tick size on stock returns.Westart with a simple simulation to demonstrate how continuous returns become distorted after confining the price to a discrete grid governed by the tick size.Wethen move on to a novel experimental set-up that combines decimalization pilot programs and crosslisted stocks in New York and Toronto. This allows us to observe a set of stocks traded simultaneously under two different ticks while holding all security-specific characteristics fixed. We then study the normality of the return distributions and carry out fits to the chosen distribution models. Our empirical findings are somewhat mixed and in some cases appear to challenge the simulation results.

Authors: Onnela, J; Toyli, J; Kaski, K

• Publication date: 2009-01-01