Decimal Trading and Market Impact (original) (raw)
Related papers
The effect of decimalization on the components of the bid-ask spread
Journal of Financial Intermediation, 2003
Previous empirical studies that decompose the bid-ask spread were done when securities traded in discrete price points equal to one-sixteenth or one-eighth of a dollar. These studies concluded that inventory and adverse-selection costs were economically insignificant compared to order-processing costs. Natural questions arise as to: (i) whether price discreteness allowed market makers to enjoy excess rents, thus reducing the significance of the inventory and adverse selection costs; (ii) whether discreteness decreased the traders' incentives to gather information; or (iii) whether methodologies previously employed mis-estimated the inventory and the adverseselection costs. We show that the recent conversion to decimal pricing results in significantly tighter spreads. However, the dollar value of spreads attributed to adverse selection and inventory costs do not change significantly. Almost all of the reduction occurs in the order-processing component. As a result, inventory and adverse-selection costs now account for a significantly larger proportion of the traded spreads. A plausible explanation is that the minimum tick size constraint previously in place under fractional pricing allowed market makers to enjoy spreads that were larger than their actual costs.
Journal of Financial Markets, 1998
We study the impact of Toronto Stock Exchange (TSE) decimalization on the competition for order flow. For TSE stocks cross-listed on the NYSE/AMEX, spreads decrease by 27% on the TSE and do not change on the NYSE/AMEX. For TSE stocks cross-listed on Nasdaq, spreads decline by 16% and 8% on the TSE and Nasdaq, respectively. However, order flow does not migrate from U.S. markets to the TSE. Our results indicate that the savings in TSE transaction costs do not offset the benefits of trading on the NYSE/AMEX, and that Nasdaq dealers might not operate as efficiently as perfect competition warrants.
The competitive effects of US decimalization: Evidence from the US-listed Canadian stocks
Journal of Banking and Finance, 2003
This paper analyzes the impact of US decimalization on the Canadian stocks listed on the Toronto Stock Exchange (TSE) and either the New York Stock Exchange (NYSE) or National Association of Securities Dealers Automated Quotation System (Nasdaq) in the US. Using a sample of 126 firms, we find that the US trading of these stocks increases after decimalization, but this increase is not at the expense of TSE volume. Indeed, the TSE volume increases substantially for those securities that are traded on Nasdaq and increases marginally for those securities that are traded on the NYSE. Most of the increase in volume is in retailsized trades. The bid-ask spreads and the quote depths decline on all exchanges, but by a greater amount in the US than in Canada. The depths on the NYSE decline from being above the TSE depths to well below the TSE depths. We also find that the decline in the TSE spread is directly related to the size of the firm and to the decline in the US spread, and is inversely related to the pre-decimalization ratio of spreads on the US exchange and the TSE. Overall, our results indicate that the US decimalization had the desired positive impact on trading in both the US and Canada, with a decrease in spreads and an increase in retail-sized trading.
2002
We examine the effect of decimalization on institutional investors using proprietary data. We find no evidence that decimalization has increased trading costs for institutions. In fact, we find an average decrease of 13 basis points, or roughly $224 million a month in savings of institutional trading costs following the move to decimal trading. We find little differences in institutional order routing practices overall though smaller and easier to fill orders are routed more often to electronic brokers while larger and more difficult to fill orders are sent to traditional brokers following decimalization. There is an increase in trading costs of orders routed to electronic and independent research brokers, while costs of trading with full service and soft dollar brokers have gone down. Interestingly, we find a reduced usage of soft dollar brokers suggesting that decimalization may have altered the incentives of this multi-billion dollar industry. Our results survive extensive partitioning of the data and differ in spirit from those reported around the transition of the minimum tick size from eighths to sixteenths. Our results are also surprising in light of an oft-repeated complaint among professional traders that liquidity is hard and expensive to find in a post-decimal trading milieu. Our findings have important regulatory implications.
Has decimalization hurt institutional investors
2003
We examine the effect of decimalization on institutional investors using proprietary data. We find no evidence that decimalization has increased trading costs for institutions. In fact, we find an average decrease of 13 basis points, or roughly $224 million a month in savings of institutional trading costs following the move to decimal trading. We find little differences in institutional order routing practices overall though smaller and easier to fill orders are routed more often to electronic brokers while larger and more difficult to fill orders are sent to traditional brokers following decimalization. There is an increase in trading costs of orders routed to electronic and independent research brokers, while costs of trading with full service and soft dollar brokers have gone down. Interestingly, we find a reduced usage of soft dollar brokers suggesting that decimalization may have altered the incentives of this multi-billion dollar industry. Our results survive extensive partitioning of the data and differ in spirit from those reported around the transition of the minimum tick size from eighths to sixteenths. Our results are also surprising in light of an oft-repeated complaint among professional traders that liquidity is hard and expensive to find in a post-decimal trading milieu. Our findings have important regulatory implications.
Order preferencing and market quality on NASDAQ before and after decimalization
Journal of Financial Economics, 2004
Despite the widely held belief that order preferencing affects market quality, no hard evidence exists on the extent and determinants of order preferencing and its impact on dealer competition and execution quality. This study shows that the bid-ask spread (dealer quote aggressiveness) is positively (negatively) related to the proportion of internalized volume during both the pre-and post-decimalization periods. Although decimal pricing led to lower order preferencing on NASDAQ, the extent of order preferencing after decimalization is higher than what prior studies had predicted. The price impact of preferenced trades is smaller than that of unpreferenced trades and preferenced trades receive greater (smaller) size (price) improvements than unpreferenced trades. r
Did decimalization hurt institutional investors
Journal of Financial Markets, 2005
We examine institutional trading costs around the move to penny size ticks in 2001 (i.e., decimalization). We find that overall trading costs declined, with improvements in most partitions across order size, firm size, and manager style. Improvements were most pronounced for orders that were executed over multiple days and for stocks where the minimum tick sizes were likely to have been binding. However, costs did increase for orders executed within a single day. The improvements we document contrast with changes accompanying the reduction of minimum ticks to sixteenths in 1997 though, in both cases, results suggest that more patient traders fare relatively better than those that demand immediacy. r 2005 Elsevier B.V. All rights reserved.
Decimalization, IPO aftermath, and liquidity
Review of Quantitative Finance and Accounting, 2015
This paper investigates the effect of decimalization on the aftermarket trading of NYSE-listed IPOs. We find that after decimalization, the relation between spreads and underpricing becomes negative, which suggests that the benefits from the increased price competition accrue more to hot IPOs. The depths are generally smaller post-decimalization because of the higher probability of front-running that aggravates the costs of adverse selection and limit order submission. In addition, we show that underwriters still provide price support but are only willing to cover the initial short position if it is still profitable post-decimalization. We also find that decimal pricing does not change the flipping strategy of institutions for cold IPOs as flipping is likely bounded by underwriter price support and shares allocation. Institutions, however, tend to flip more hot IPOs in the post-rather than pre-decimalization period, suggesting that the cost of flipping is much lower for those share prices with a substantial run-up during aftermarket trading.
Adverse selection costs for NASDAQ and NYSE after decimalization
International Review of Financial Analysis, 2009
a b s t r a c t respectively. In this paper, we compare adverse selection component of the bid-ask spread for NASDAQ and NYSE stocks after decimalization using the data from May 2001 and July 2001. We find that the adverse selection component of the bid-ask spread is significantly lower on NASDAQ than on NYSE, and these differences cannot be attributed to the differences in the characteristics of the stocks traded in the two markets. In addition, we find that the adverse selection costs increase with trade size on NYSE, however there is no monotonic pattern observed for NASDAQ stocks. Lastly, we report that although the order flows arrived in the two markets are significantly different, they can at best explain a small portion of the observed differences in adverse selection costs.
International Review of Financial Analysis, 2009
We analyze how U.S. decimalization affects stocks cross-listed in France (Euronext) and the U.S. (NYSE). The French stocks examined are much larger than the non-U.S. stocks examined in prior studies of decimalization, and their U.S. trading is likely to be dominated by institutions. So, we explore whether a reduction in depths in the U.S. due to decimalization makes the U.S. market less competitive for institutions trading these French stocks. We find evidence consistent with the above. First, the average NYSE trade size for these stocks relative to that on Euronext declines substantially after decimalization. Second, we categorize individual trades by the number of shares traded. We find that mainly driven by large trades, the NYSE proportion of trading of French firms declines markedly after decimalization. Third, using regression analysis, we find that the decline in the U.S. share of institutional trading volume is significantly positively related with the decline in NYSE depths relative to Euronext, and the decline is greater for French firms. Overall, we find consistent results indicating a migration of institutional order flow in French firms to France after NYSE decimalization. Also, intraday analysis indicates that the institutional volume in both France and the U.S. is greatest when both the markets are open. (S. Sabherwal).