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Tick Size, Competition for Liquidity Provision, and Price Discovery: Evidence from the U.S. Treasury Market

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  • Michael Fleming

    (Federal Reserve Bank of New York, New York, New York 10045)

  • Giang Nguyen

    (Smeal College of Business, Pennsylvania State University, University Park, Pennsylvania 16802)

  • Francisco Ruela

    (Booth School of Business, University of Chicago, Chicago, Illinois 60637)

Abstract

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. Using difference-in-differences regressions around the November 19, 2018, tick size reduction in the 2-year Treasury note and a similar change in the 2-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 smaller tick size environment. Last, we find a significant shift in short-run 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 larger-tick 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.

Suggested Citation

  • Michael Fleming & Giang Nguyen & Francisco Ruela, 2024. "Tick Size, Competition for Liquidity Provision, and Price Discovery: Evidence from the U.S. Treasury Market," Management Science, INFORMS, vol. 70(1), pages 332-354, January.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:1:p:332-354
    DOI: 10.1287/mnsc.2022.4663
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    1. Lin, Hai & Lo, Ingrid & Qiao, Rui, 2021. "Macroeconomic news announcements and market efficiency: Evidence from the U.S. Treasury market," Journal of Banking & Finance, Elsevier, vol. 133(C).

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    More about this item

    Keywords

    tick size; bid-ask spread; market liquidity; price efficiency; price discovery; liquidity provision; Treasury securities; dealers; principal trading firms; high frequency trading firms;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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