When bigger is better: The impact of a tiny tick size on undercutting behavior

37 Pages Posted: 25 Jun 2018 Last revised: 26 Jun 2020

See all articles by Anne Haubo Dyhrberg

Anne Haubo Dyhrberg

Wilfrid Laurier University

Sean Foley

Macquarie University

Jiri Svec

The University of Sydney - Discipline of Finance

Date Written: June 11, 2019

Abstract

We show that economically insignificant tick sizes encourage undercutting behavior, harming market quality. While theory shows increasing tick sizes in unconstrained markets reduces undercutting, improving market quality, pricing grids of most markets are too coarse to test this. We examine a cryptocurrency market with infinitesimal tick sizes, where undercutting limit orders affords price priority without economic cost. Increasing tiny tick sizes reduces undercutting behavior, increasing liquidity provision and quoted depth, reducing transactions costs for both institutional and retail-sized trades while simultaneously decreasing short-term volatility. We show that tiny tick sizes are not optimal, supporting increased minimum trading increments in tick-unconstrained markets.

Keywords: market microstructure, tick size, trading behavior, bitcoin, cryptocurrency

JEL Classification: G14, G15, C580

Suggested Citation

Dyhrberg, Anne Haubo and Foley, Sean and Svec, Jiri, When bigger is better: The impact of a tiny tick size on undercutting behavior (June 11, 2019). Available at SSRN: https://ssrn.com/abstract=3194932 or http://dx.doi.org/10.2139/ssrn.3194932

Anne Haubo Dyhrberg

Wilfrid Laurier University ( email )

75 University Ave W
waterloo, ontario N2L 3C5
Canada

Sean Foley (Contact Author)

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia
0417702600 (Phone)

Jiri Svec

The University of Sydney - Discipline of Finance ( email )

P.O. Box H58
Sydney, NSW 2006
Australia
+61 2 9036 6241 (Phone)

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