The effects of a tick-size reduction on the liquidity in a pure limit order market: evidence from Hong Kong

Abstract

This study empirically investigates the effects of a tick-size reduction on the liquidity of the Hong Kong stock market, a pure limit order market. By using a modified cumulative depth to measure liquidity, we find that overall liquidity for liquid stocks is significantly decreased after the tick-size reduction, which implies that the tick-size reduction probably increases the transaction costs of large institutions. Furthermore, the results show that trading sizes in high-volume stocks are decreased, probably because large institutional traders use smaller size transactions to hedge the adverse effect caused by the decreased liquidity.

Keywords:

• tick-size reduction
• liquidity
• limit order market

JEL Classification:

• G10
• G12
• G14

Acknowledgements

This work is partially supported by NSFC (No. 71003021), NCET (NCET-10-0337) and Program for Innovative Research Team in UIBE.

Notes

¹ We also find the deceased spread and depth after the tick-size reduction. The results are not presented here for saving space.

² We also use 90 PS as alternative definition. The results, not presented here, are qualitatively similar.

³ This number somewhat overestimates the effect of the tick-size reduction for some large firms. The cross-section median is much lower.