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April 2019 Revised April 2022
JEL classification: G12, G14, G18
Authors: Michael J. Fleming, Giang Nguyen, and Francisco Ruela
This paper studies how a tick size change affects market quality, price discovery, and the competition for liquidity provision by dealers and high-frequency trading firms (HFTs) in the U.S. Treasury market. Employing difference-in-differences regressions around the November 19, 2018 tick size reduction in the two-year Treasury note and a similar change for the two-year futures eight weeks later, we find significantly improved market quality. Moreover, dealers become more competitive in liquidity provision and price improvement, consistent with the hypothesis that HFTs find liquidity provision less profitable in the lower tick size environment. Lastly, we find a significant shift in price discovery toward the cash market, which then reverses when the futures market tick size is reduced, suggesting that the finer pricing grid in the cash market allows traders to act on small information signals that are not profitable to exploit in the coarser pricing grid of the futures market. Our findings suggest that reducing the tick size in tick-constrained and highly liquid markets like the Treasury market is on balance beneficial.
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index. html. Use of TRACE data were subject to review by the Financial Industry Regulatory Authority and the Inter-Agency Working Group for Treasury Market Surveillance (members of which include the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Department of the Treasury, the Federal Reserve Bank of New York, and the U.S. Securities and Exchange Commission) prior to circulation. Use of BrokerTec data were subject to review by BrokerTec Americas LLC prior to circulation.
Giang Nguyen
The author declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index. html. Use of TRACE data were subject to review by the Financial Industry Regulatory Authority and the Inter-Agency Working Group for Treasury Market Surveillance (members of which include the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Department of the Treasury, the Federal Reserve Bank of New York, and the U.S. Securities and Exchange Commission) prior to circulation. Use of BrokerTec data were subject to review by BrokerTec Americas LLC prior to circulation.
Francisco Ruela
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index. html. Use of TRACE data were subject to review by the Financial Industry Regulatory Authority and the Inter-Agency Working Group for Treasury Market Surveillance (members of which include the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Department of the Treasury, the Federal Reserve Bank of New York, and the U.S. Securities and Exchange Commission) prior to circulation. Use of BrokerTec data were subject to review by BrokerTec Americas LLC prior to circulation.
