Professor Justin McCrary is a Professor of Law at the University of California at Berkeley Law School who is the Samuel Rubin Visiting Professor of Law at Columbia Law School in for the Fall 2017 semester.
Using data from the 2016-2018 tick size pilot study, we examine the efficacy of using wider tick sizes to subsidize market-making in small capitalization stocks. We demonstrate that realized spreads decay quickly within the initial microseconds of a trade, consistent with market makers being subject to adverse selection from asymmetrical speed among market makers. The effect reduces the subsidy offered by wider tick sizes, particularly for non-HFT market makers. The profit subsidy from wider tick sizes is also compromised by a significant shift in trading to “taker/maker” exchanges and to midpoint trading in non-exchange venues. The pilot’s exception for midpoint trades also accounts for the fact that nearly a third of trading remains in non-exchange venues despite the inclusion of a trade-at rule. Overall, these findings point to considerable inefficiencies in the pilot study’s goal of using wider tick sizes to subsidize liquidity provision in small capitalization stocks.