The impact of tick size on market quality: an empirical investigation of the stock exchange of Hong Kong

Abstract

Previous studies rely on the event-study technique to investigate the impact of tick size change on market quality. We take a more powerful approach by examining the market quality of a set of stocks which would experience the largest impact of tick size change - - stocks with prices falling around thresholds in the sliding tick size schedules. We choose the Stock Exchange of Hong Kong for our study because of its two desirable features: (1) it offers a wide range of tick sizes and threshold prices which allows us to gauge the differential impact of different degrees of trading cost savings due to the tick size reduction; (2) it displays limit orders beyond the best quote which is essential for drawing a correct inference regarding the impact of tick size on market depth. Like previous studies, we find that the bid-ask spread decreases and the depth measured at the best quotes decrease after the tick size is reduced. ln contrast to previous studies, however, we conclude the market quality increase after a reduction in tick size. In addition to observing a smaller spread, we also observe an increase in the market depth, when it is adequately measured to take into account of the orders beyond the best quotes. Furthermore, the volume increases with the reduction of tick size as well The biggest improvement in the market quality is found in smaller stocks, which see more economically significant changes in tick size than larger stocks.