Tick size and price diffusion
AbstractA tick size is the smallest increment of a security price. It is clear that at the shortest time scale on which individual orders are placed the tick size has a major role which affects where limit orders can be placed, the bid-ask spread, etc. This is the realm of market microstructure and there is a vast literature on the role of tick size on market microstructure. However, tick size can also affect price properties at longer time scales, and relatively less is known about the effect of tick size on the statistical properties of prices. The present paper is divided in two parts. In the first we review the effect of tick size change on the market microstructure and the diffusion properties of prices. The second part presents original results obtained by investigating the tick size changes occurring at the New York Stock Exchange (NYSE). We show that tick size change has three effects on price diffusion. First, as already shown in the literature, tick size affects price return distribution at an aggregate time scale. Second, reducing the tick size typically leads to an increase of volatility clustering. We give a possible mechanistic explanation for this effect, but clearly more investigation is needed to understand the origin of this relation. Third, we explicitly show that the ability of the subordination hypothesis in explaining fat tails of returns and volatility clustering is strongly dependent on tick size. While for large tick sizes the subordination hypothesis has significant explanatory power, for small tick sizes we show that subordination is not the main driver of these two important stylized facts of financial market.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1009.2329.
Date of creation: Sep 2010
Date of revision: Oct 2010
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-09-25 (All new papers)
- NEP-FMK-2010-09-25 (Financial Markets)
- NEP-MST-2010-09-25 (Market Microstructure)
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