Tick Size Tolls: Can a Trading Slowdown Improve Price Discovery?

Tick Size Tolls: Can a Trading Slowdown Improve Price Discovery?

By Charles M. C. Lee, Edward M. Watts
May 9,2019Working Paper No. 3732

This study examines how an increase in tick size affects algorithmic trading (AT), fundamental information acquisition (FIA), and the price discovery process around earnings announcements (EAs). Leveraging the SEC’s randomized “Tick Size Pilot” experiment, we show a tick size increase results in a decline across four commonly-used AT proxies. This decrease in AT is accompanied by a sharp drop in abnormal volatility and volume around EAs.  More importantly, we find increased FIA in the preannouncement period.  Specifically, we show: (a) treatment firms’ pre-announcement returns better anticipate next quarter’s standardized unexpected earnings; (b) these firms experience an increase in EDGAR web traffic prior to EAs; and (c) they exhibit a drop in price synchronicity with index returns. Taken together, our evidence suggests that while an increase in tick size reduces AT and abnormal market reaction after EAs, it also increases FIA activities prior to EAs.