3rd CEPR-Imperial-Plato Market Innovator (MI3) Conference 2019
Tick Size Wars. Competitive Tick Size Regimes and Trader Behavior
Sean Foley (University of Sydney)
Tom Grimstvedt Meling (University of Chicago)
Bernt Arne Ødegaard (University of Stavanger)
Sean Foley Sean is a Senior Lecturer in Finance and has been teaching at the University of Sydney since 2014. Sean holds a Bachelor of Economics, as well as a First-Class Honours degree and PhD in Finance, all of which were awarded by the University of Sydney. Sean researches market regulation and efficiency, focussing on both global equities and the emerging cryptocurrency markets.
Tom Grimstvedt Meling Tom Grimstvedt Meling is a Researcher at the Norwegian School of Economics, having previously been a postdoctoral scholar at the University of Chicago, Becker Friedman Institute. His main research interests are market microstructure and corporate finance.
Bernt Arne Ødegaard is an Adjunct Professor at NHH alongside his position as Professor of Finance at the University of Stavanger (UiS). He was awarded his PhD of Finance from Carnegie Mellon University in 1992, and wrote a thesis paper on fixed income securities which was published in the Journal of Finance (1997).
About the paper
This paper is concerned with exploring the impact of stock exchanges ‘vying for market share by competing on tick sizes, where three pan-European exchanges unexpectedly reduced their tick sizes relative to the national listing exchanges.’
Specifically, it looks at the impacts of pure exchange tick size competition, and the immediate responses of HFT liquidity suppliers.
It seeks to identify optimal tick size regimes, and broader questions around exchange price competition, including dark pools and inverted free structure.
It starts by outlining the ‘Tick Size War’ of 2009 – three phases where Chi-X significantly reduced its tick size on all Scandinavian stocks on the 1st of June, followed by Turquoise on the 8th and then BATS Europe on the 15th. In Fall, there was a Pan-European agreement on common tick sizes across all exchanges, resolving the tick war. The roots of this war are traced back to 2007 with MiFID I.
The paper monitors relative spreads, market shares and depth across the time period of the tick war in order to draw insights around cause and effect, looking at the competitive elements around tick sizes, with particular reference to HFTs and regulatory solutions.
Over the course of the tick war, we see a series of stock exchanges and trading platforms modifying their tick size, with LSE, Turquoise, BATS and Chi-X all lowering from a 0.25 initial tick down to 0.05 by the 22nd of June 2009.
Following the first lowering of tick sizes, we see the spreads (transaction costs) fall in both away and home markets. The depth is unchanged, and volume increases in both home and away markets. This change is volume is perhaps most surprising, and the paper speculates that this is likely due to across-market arbitrage activity.
In the pre-war to post-harmonization phase, spreads fall again in both home and away markets. Furthermore, the depth falls, and volume decreases in home markets and increases in away markets.
The paper also explores how HFTs used the small tick markets – finding that they use them to undercut the main market by minimal ticks – they do not use the small-tick market to move prices towards a less constrained equilibrium.
The overall findings of the paper were that entrant exchanges undercut tick size to gain market share: a competitive advantage. Old exchanges lost significant proportions of the market (from 100% – 50% of time at best quote, and from 98% to 92% of trading volume).
In terms of quoting behaviours, traders use small-tick market to undercut the main market by one tick, not for price competition within the small-tick market. In effect, explicit tick size competion leads to undercutting behaviours.
In the case of the HFT field, market makers undercut by only one new tick, leading to no new equilibrium spread, and so regulation is required to avoid explicit tick size competition. The upshot of the harmonized ticks is an implicit competition in the form of midpoint dark trading in Europe (or fractional dark trading in the US), large in scale blocks or inverted fee venues.
The paper concludes that narrower, unconstrained tick sizes may eliminate this competitive conduct.
Images: Muhammad Ashraf ©2019