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Tick Size Tolls: Can a Trading Slowdown Improve Price Discovery?

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  • Lee, Charles M. C.

    (Stanford University - Graduate School of Business)

  • Watts, Edward M.

    (Stanford University, Graduate School of Business, Students)

Abstract

This study examines how an increase in tick size affects algorithmic trading (AT), fundamental information acquisition (FIA), and the price discovery process around earnings announcements (EAs). Leveraging the SEC’s randomized “Tick Size Pilot†experiment, we show a tick size increase results in a universal decline across four commonly-used proxies for AT. This decrease in AT is accompanied by a sharp drop in abnormal volatility and volume around EAs. More importantly, we find causal evidence of increased FIA in the pre-announcement period. Specically, we show that with a larger tick size: (a) treatment firms’ pre-announcement returns better anticipate next quarter’s standardized unexpected earnings (SUEs); (b) their pre-announcement returns capture more of their total returns; (c) they experience an increase in EDGAR web trac in the days leading up to EAs; and (d) they exhibit a drop in price synchronicity with index returns. Taken together, our evidence shows that while an increase in tick size reduces AT and abnormal market reaction after EAs, it also increases FIA activities prior to EAs.

Suggested Citation

  • Lee, Charles M. C. & Watts, Edward M., 2018. "Tick Size Tolls: Can a Trading Slowdown Improve Price Discovery?," Research Papers 3732, Stanford University, Graduate School of Business.
    • Handle: RePEc:ecl:stabus:3732
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    Cited by:

    1. Kemme, David M. & McInish, Thomas H. & Zhang, Jiang, 2022. "Market fairness and efficiency: Evidence from the Tokyo Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 134(C).
    2. Blankespoor, Elizabeth & deHaan, Ed & Marinovic, Iván, 2020. "Disclosure processing costs, investors’ information choice, and equity market outcomes: A review," Journal of Accounting and Economics, Elsevier, vol. 70(2).
    3. Markus Baldauf & Joshua Mollner, 2020. "High‐Frequency Trading and Market Performance," Journal of Finance, American Finance Association, vol. 75(3), pages 1495-1526, June.
    4. Chung, Kee H. & Lee, Albert J. & Rösch, Dominik, 2020. "Tick size, liquidity for small and large orders, and price informativeness: Evidence from the Tick Size Pilot Program," Journal of Financial Economics, Elsevier, vol. 136(3), pages 879-899.
    5. Albuquerque, Rui & Song, Shiyun & Yao, Chen, 2020. "The price effects of liquidity shocks: A study of the SEC’s tick size experiment," Journal of Financial Economics, Elsevier, vol. 138(3), pages 700-724.
    6. Corey Garriot & Ryan Riordan, 2020. "Trading on Long-term Information," Staff Working Papers 20-20, Bank of Canada.
    7. Stanislav Anatolyev & Sergei Seleznev & Veronika Selezneva, 2019. "Does Index Arbitrage Distort the Market Reaction to Shocks?," CERGE-EI Working Papers wp651, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    8. Chakrabarty, Bidisha & Moulton, Pamela C. & Wang, Xu (Frank), 2022. "Attention: How high-frequency trading improves price efficiency following earnings announcements," Journal of Financial Markets, Elsevier, vol. 57(C).

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