Tick size change and liquidity provision on the Tokyo stock exchange

Abstract

The Tokyo Stock Exchange (TSE) introduced a change in its minimum tick sizes on April 13, 1998, for stocks traded at certain price ranges. We investigate liquidity and market quality of the stocks affected by the tick size change, using a unique and comprehensive tick-by-tick data. We find that the quoted spread (effective spread) declined significantly by 20 to 50 percent (by 24 to 60 percent) after the tick size change. Reductions in spread are greater for firms with greater tick size reductions, greater trading activity, and less degree of information asymmetry. We find no definite evidence of an increase in trading volume. This implies that the savings in transaction cost for investors due to spread reduction came from a wealth transfer from limit order traders, the main suppliers of liquidity to the TSE. Consistent with this story, we find that price competition in the limit order book increased substantially after the tick size change.