Tick Size Wars: The Market Quality Effects of Pricing Grid Competition

March 18, 2023

Tick Size Wars: The Market Quality Effects of Pricing Grid Competition
Sean Foley, Tom G Meling, Bernt Arne Ødegaard
Review of Finance, Volume 27, Issue 2, March 2023, Pages 659–692, https://doi.org/10.1093/rof/rfac032

We examine the market quality effects of explicit tick size competition between trading venues. The laboratory is the European “tick size war” of 2009 in which, owing to the absence of a regulator-mandated uniform tick size, entrant trading venues were able to undercut the tick sizes of the primary exchanges.

Exchanges that reduced their tick size immediately captured the market shares of both quoted and executed volume from the exchanges that kept their ticks large, as shown in the below figure. This tick size competition improves market quality, reducing trading costs and increasing both aggregate depth and volume. These market quality improvements are strongest in stocks where the bid-ask spread was previously most constrained by the tick size, with liquidity providers using the finer pricing grid to engage in price competition.

Our findings are very much consistent with the notion that the “one size fits all” approach currently taken to tick size regulation globally may require revision.

Figure 1

Changing pre–trade and volume market shares. Oslo Stock Exchange. June: Entrant markets lower tick size relative to Oslo. September: Tick Sizes same across all market.