Increasing the Tick: Examining the Impact of the Tick Size Change on Maker‐Taker and Taker‐Maker Market Models

Published date01 August 2019
Date01 August 2019
The Financial Review 54 (2019) 417–449
Increasing the Tick: Examining the Impact
of the Tick Size Change on Maker-Taker
and Taker-Maker Market Models
Justin Cox, Bonnie Van Ness, and Robert Van Ness
University of Mississippi
We investigate the effects of an increase in tick size on order and trading flow across
market fee models. Using the pilot firms in the U.S. Securities and Exchange Commission’s
Tick Size Pilot Program, we document that trade and order volume declines on maker-takerfee
models after the tick size implementation. We find that the inverted fee models (taker-maker)
experience an increase in both trade and order volume. Additionally, we find that a tick size
adjustment has a substantial influence on market participation in maker-taker fee models. We
also find that measures of both hidden and algorithmic trading decline with an increasing tick
size, which is strongly moderated by the differences in the maker-taker and taker-maker fee
Keywords: tick size, maker-taker, algorithmic trading, hidden liquidity
JEL Classifications: G10, G12, G14, G18, L1
1. Introduction
On May 6, 2015, the U.S. Securities and Exchange Commission (SEC) issued
an order approving the National Market System (NMS) Plan to implement a Tick
Corresponding author: 329 Holman Hall, Universityof Mississippi, University, MS 38677; Phone: (662)
915-6940; Fax (662) 915-7968; E-mail:
C2019 The Eastern Finance Association 417
418 J. Cox et al./The Financial Review 54 (2019) 417–449
Size Pilot Program under the direction of both the National Securities Exchange and
Financial Industry Regulatory Authority (FINRA). The major function of the Tick
Size Pilot is to increase the tick size for smaller capitalized securities with hopes of
increasing trading, liquidity, and overall market quality in thesesecurities. While not
central to the Tick Size Pilot’s focus, we use the tick size change to examine recent
theoretical predictions that suggest changing the tick size increment might influence
trading activity across markets with different fee models.1Dating back to the turn
of the century, market fee models incentivizing liquidity providers via rebates (i.e.,
maker-taker) have become commonplace for many U.S. stock markets.2Recently,
an inverted fee model, the taker-maker fee model, is being used by three U.S. stock
markets. This fee model allows for rebates to accrue to liquidity demanders. To the
extent that changes in the tick size influences the decision to supply or demand
liquidity, trading activity across market fee models may be influenced.
Extant literature suggests that the tick size increment plays a prominent role in
determining the level of undisplayed or hidden orders. Specifically, in cases where
the tick size acts as a binding constraint—when the bid-ask spread equals the tick
size—a change in the tick size can impact not only transaction costs and trading
volume (Harris, 1991, 1994) but also order exposure (Harris, 1996, 1997).3Studying
the Tick Size Pilot Program allows us to answer questions pertaining to the relation
between tick sizes and order exposure, not only in the aggregate market but also
across different market fee models, such as maker-taker and taker-maker,which cater
to different clienteles. The taker-maker inverted fee model allows traders to pay a
fee to provide liquidity while takers of liquidity (i.e., liquidity demanders) earn a
rebate. This fee model appeals to traders because it allows them to undercut prices
and bypass the queue via paying the venue fee.
The inverted fee model (i.e., taker-maker) provides incentives for brokers to
route orders to taker-maker models despite another exchange offering the same price.
As Angel, Harris and Spatt (2015) document, the taker-maker model effectively
attenuates the presence of a minimum tick size since it allows a limit order trader to
bypass an existing quote by simply paying an access fee rather than the full tick. Thus,
taker-maker pricing allows dealers and traders a path to bypass limit order queues.
Angel, Harris and Spatt (2015) suggest that the SEC prohibit both fee models or, to a
lesser extent, allow clients, not brokers, to have direct access to all fees and rebates.
They also suggest that due to the fragmented markets that exist today, increasing the
1Foucault, Kadan and Kandel (2013) posit that a change in the tick size impacts annualized revenue
between optimal and uniform pricing policy. They further conclude that a coarser price grid is preferred
by maker-taker fee model platforms.
2See page 4 of
3Harris (1994, 1996, 1997) argues that changes in the minimum price variation influence the level of
displayed orders. Aitken, Berkman and Mak (2001) show that traders are more likely to hide their orders
when the tick size is small. Cebiroglu, Hautsch and Horst (2014) provide a theoretical argument that tick
sizes that are too large on a relative basis can preventlatent traders from trading publicly.
J. Cox et al./The Financial Review 54 (2019) 417–449 419
tick size will incentivize dealers and proprietary traders to engage in quote-matching
practices that allow traders to undercut current limit orders. Likewise,Buti, Consonni,
Rindi, Wen and Werner (2015) argue a wider tick increases the presence of queue-
jumping activity to gain priority of resting limit orders. Thus, to the extent we findthat
increasing the tick size increases the presence of taker-maker activity,one unintended
consequence is that quote-matching could increase.
One argument in support of an increase in the tick size is to reduce fast (non-
human) traders, thereby favoring human traders (Weild, Kim and Newport, 2012).
Several studies suggest that the relative tick size influences the level of nonhuman
or algorithmic trading. For example, Ye and Yao (2014) argue that a larger tick size
hinders price competition and increases the role of time priority, in which traders
with speed benefit. Likewise, O’Hara, Saar and Zhong (2015) posit and find that a
larger relative tick size allowshigh-frequency market makers to become more aggres-
sive, undercutting resting limit orders. Further, Foucault, Kadan and Kandel (2013)
suggest that the trading frequency on market fee models may influence the level of
algorithmic trading, indicating a positive relation between overall trading activity
and algorithmic trading. We add to these recent studies by analyzing the effects of an
increase in the minimum tick size on the level of algorithmic trading. Specifically,
we identify if measures of algorithmic trading change across market fee models,
maker-taker and taker-maker, using algorithmic trading proxies outlined by Weller
We also analyze changes in hidden liquidity around the tick size change. One
component of the Tick Size Pilot is that it contains a “trade-at prohibition.” The
“trade-at prohibition” is aimed at curbing the level of price matching by trading
centers that are not already offering or displaying a quote at the best price—a practice
that is often associated with off-exchange trading centers or “dark” pools. Comerton-
Forde, Gregoire and Zhong (2017) provide corroborating evidence that dark trading
activity changes for the pilot firms subject to the “trade-at prohibition.” Weexamine
the relation between the larger tick size and hidden trading activity as hidden and dark
trading are not exact substitutes (see Degryse, Tombeur and Wuyts, 2015). Hidden
trading refers to the trading practice of using hidden limit orders in the lit venue limit
order book, while dark trading refers to off-exchange trading where private forums
offer market participants pre-trade transparency. For instance, a change in the tick
size may result in varying levels of hidden and dark trading activity as a wider tick
size on a lit venue (i.e., quoting exchange) may incentivize traders to transact in
the dark venue since dark venues offer more price improvement than the lit venue.
On the other hand, a wider tick size may reduce the level of hidden liquidity since
4Ye and Yao (2014) provide a full discussion as to the level of high-frequency trading across market
fee models. They argue that increasing the relative tick size favors high-frequency traders (HFTs) since
it eliminates the non-HFTs’ advantage to undercut HFTs because of their ability to quote better prices.
However, Ye and Yao suggest that non-HFTs will migrate toward taker-maker venuesto bypass tick size
constraints primarily to avoid undercutting HFTs.

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