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Tick size, price grids and market performance: Stable matches as a model of market dynamics and equilibrium

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  • Plott, Charles
  • Roll, Richard
  • Seo, Han
  • Zhao, Hao

Abstract

The tick size in a financial market is the minimum allowable difference between ask and bid prices. By the rules of each exchange, no transactions can occur within the tick interval. The impact of tick size is an ongoing controversy which we study by experimental methods, whose simplicity helps distinguish among competing models of complex real-world securities markets. We observe patterns predicted by a matching (cooperative game) model. Because a price grid interferes with a competitive equilibrium and restrictions on order flow interfere with information aggregation, the matching model provides predictions when the competitive model cannot, although their predictions are the same when a competitive equilibrium does exist. Our experiments examine stable allocations, average prices, timing of order flow, information flow and price dynamics. Larger tick size invites more speculation, which in turn increases liquidity. However, increased speculation leads to inefficient trades that otherwise would not have occurred.

Suggested Citation

  • Plott, Charles & Roll, Richard & Seo, Han & Zhao, Hao, 2019. "Tick size, price grids and market performance: Stable matches as a model of market dynamics and equilibrium," Games and Economic Behavior, Elsevier, vol. 118(C), pages 7-28.
    • Handle: RePEc:eee:gamebe:v:118:y:2019:i:c:p:7-28
    DOI: 10.1016/j.geb.2019.08.004
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    Cited by:

    1. Brice Corgnet & Cary Deck & Mark DeSantis & Kyle Hampton & Erik O. Kimbrough, 2023. "When Do Security Markets Aggregate Dispersed Information?," Management Science, INFORMS, vol. 69(6), pages 3697-3729, June.
    2. He, Simin & Wu, Jiabin & Zhang, Hanzhe, 2021. "Experimental and Noncooperative Analyses of Decentralized Matching with Transfers," Working Papers 2021-2, Michigan State University, Department of Economics.
    3. Herings, P. Jean-Jacques, 2020. "Expectational Equilibria in Many-to-one Matching Models with Contracts - A Reformulation of Competitive Equilibrium," Research Memorandum 018, Maastricht University, Graduate School of Business and Economics (GSBE).

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    More about this item

    Keywords

    Price grid; Experiment; Matching; Assignment; Equilibration; Efficiency;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact

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