Tick Size, Price Grids and Market Performance: Stable Matches as a Model of Market Dynamics and Equilibrium

Abstract

This paper reports experiments motivated by ongoing controversies regarding tick size in markets. The minimum tick size in a market dictates discrete values at which bids and asks can be tendered by market participants. All transaction prices must occur at these discrete values, which are established by the rules of each exchange. The simplicity of experiments helps to distinguish among competing models of complex real-world securities markets. We observe patterns predicted by a matching (cooperative game) model. Because a price grid damages the equilibrium of the competitive model, the matching model provides predictions where the competitive model cannot. Their predictions are the same when a competitive equilibrium exists. The experiment examines stable allocations, average prices, timing of order flow and price dynamics. Larger tick size invites more speculation, which in turn increases liquidity. However, increased speculation leads to inefficient trades that otherwise would not have occurred.