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Minimum price variations, time priority and quotes dynamics

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  • Tito Cordella
  • Thierry Foucault

Abstract

We analyze the impact of a minimum price variation (tick) and time priority on the dynamics of quotes and the trading costs when competition for the order flow is dynamic. We find that convergence to competitive outcomes can take time and that the speed of convergence is influenced by the tick size, the priority rule and the characteristics of the order arrival process. We show also that a zero minimum price variation is never optimal when competition for the order flow is dynamic. We compare the trading outcomes with and without time priority. Time priority is shown to guarantee that uncompetitive spreads cannot be sustained over time. However it can sometimes result in higher trading costs. Empirical implications are proposed. In particular, we relate the size of the trading costs to the frequency of new offers and the dynamics of the inside spread to the state of the book.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 182.

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Date of creation: Sep 1996
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Handle: RePEc:upf:upfgen:182

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Market--microstructure; tick size; time priority; quotes formation; trading costs;

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References

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  1. Domowitz, Ian, 1993. "A taxonomy of automated trade execution systems," Journal of International Money and Finance, Elsevier, vol. 12(6), pages 607-631, December.
  2. Dutta, Prajit K & Madhavan, Ananth, 1997. " Competition and Collusion in Dealer Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 245-76, March.
  3. Bacidore, Jeffrey M., 1997. "The Impact of Decimalization on Market Quality: An Empirical Investigation of the Toronto Stock Exchange," Journal of Financial Intermediation, Elsevier, vol. 6(2), pages 92-120, April.
  4. Biais, Bruno & Hillion, Pierre & Spatt, Chester, 1995. " An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse," Journal of Finance, American Finance Association, vol. 50(5), pages 1655-89, December.
  5. Angel, James J, 1997. " Tick Size, Share Prices, and Stock Splits," Journal of Finance, American Finance Association, vol. 52(2), pages 655-81, June.
  6. Garman, Mark B., 1976. "Market microstructure," Journal of Financial Economics, Elsevier, vol. 3(3), pages 257-275, June.
  7. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," Econometrica, Econometric Society, vol. 56(3), pages 571-99, May.
  8. Easley, David, et al, 1996. " Liquidity, Information, and Infrequently Traded Stocks," Journal of Finance, American Finance Association, vol. 51(4), pages 1405-36, September.
  9. Kandel, Eugene & Marx, Leslie M., 1997. "Nasdaq market structure and spread patterns," Journal of Financial Economics, Elsevier, vol. 45(1), pages 61-89, July.
  10. Ahn, Hee-Joon & Cao, Charles Q. & Choe, Hyuk, 1996. "Tick Size, Spread, and Volume," Journal of Financial Intermediation, Elsevier, vol. 5(1), pages 2-22, January.
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Citations

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Cited by:
  1. Degryse, H.A. & Jong, F.C.J.M. de & Ravenswaaij, M. van & Wuyts, G., 2002. "Aggressive Orders and the Resiliency of a Limit Order Market," Discussion Paper 2002-80, Tilburg University, Center for Economic Research.
  2. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May.
  3. Dan Ladley & Klaus Reiner Schenk-Hoppe, 2007. "Do Stylised Facts of Order Book Markets Need Strategic Behaviour?," Swiss Finance Institute Research Paper Series 07-20, Swiss Finance Institute.
  4. Michael A. Goldstein & Kenneth A. Kavajecz, . "Eighths, Sixteenths and Market Depth: Changes in Tick Size and Liquidity Provision on the NYSE," Rodney L. White Center for Financial Research Working Papers 14-98, Wharton School Rodney L. White Center for Financial Research.
  5. Large, Jeremy, 2009. "A market-clearing role for inefficiency on a limit order book," Journal of Financial Economics, Elsevier, vol. 91(1), pages 102-117, January.
  6. Kadan, Ohad, 2006. "So who gains from a small tick size?," Journal of Financial Intermediation, Elsevier, vol. 15(1), pages 32-66, January.
  7. Wuyts, Gunther, 2007. "Stock market liquidity: Determinants and implications," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/203006, Katholieke Universiteit Leuven.
  8. Calcagno, R. & Lovo, S.M., 2002. "Market Efficiency and Price Formation When Dealers are Asymmetrically Informed," Discussion Paper 2002-42, Tilburg University, Center for Economic Research.
  9. Pantisa Pavabutr & Sukanya Prangwattananon, 2009. "Tick size change on the Stock Exchange of Thailand," Review of Quantitative Finance and Accounting, Springer, vol. 32(4), pages 351-371, May.
  10. Ascioglu, Asli & Comerton-Forde, Carole & McInish, Thomas H., 2010. "An examination of minimum tick sizes on the Tokyo Stock Exchange," Japan and the World Economy, Elsevier, vol. 22(1), pages 40-48, January.
  11. LOVO, Stefano M. & CALCAGNO, R., 2001. "Market efficiency and Price Formation when Dealers are Asymmetrically Informed," Les Cahiers de Recherche 737, HEC Paris.
  12. Joel Hasbrouck, 1998. "Security Bid/Ask Dynamics with Discreteness and Clustering: Simple Strategies for Modeling and Estimation," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-042, New York University, Leonard N. Stern School of Business-.
  13. Bourghelle, David & Declerck, Fany, 2004. "Why markets should not necessarily reduce the tick size," Journal of Banking & Finance, Elsevier, vol. 28(2), pages 373-398, February.
  14. Liu, Wai-Man, 2009. "Monitoring and limit order submission risks," Journal of Financial Markets, Elsevier, vol. 12(1), pages 107-141, February.

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