Minimum Price Variations, Discrete Bid–Ask Spreads, and Quotation Sizes

Exchange minimum price variation regulations create discrete bid-ask spreads. If the minimum quotable spread exceeds the spread that otherwise would be quoted, spreads will be wide and the number of shares offered at the bid and ask may be large. A cross-sectional discrete spread model is estimated by using intraday stock quotation spread frequencies. The results are used to project 1/16 spread usage frequencies given a 1/16 tick. Projected changes in quotation sizes and in trade volumes are obtained from regression models. For stocks priced under 10, the models predict spreads would decrease 38 percent, quotation sizes would decrease 16 percent, and daily volume would increase 34 percent. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.