Tick size and spreads: The case of Nasdaq's decimalization

Recent studies by the Securities and Exchange Commission (SEC) and by academics have provided empirical evidence that Nasdaq trade execution costs are still higher than, for instance, on the NYSE. Introducing decimal pricing is one concrete plan to enhance Nasdaq's competitiveness. However, effects of tick size changes are difficult to predict. For that reason models have been required for quite a while. Capital market synergetics is appropriate to investigate the effects of market microstructure changes. In this paper, we examine the impact of a variation in Nasdaq's minimum price increment on quoted spreads. First, our findings confirm the numerical value of the decline in the average quoted spread in 1997 as an immediate effect of reducing the tick size from $1/8 to $1/16. This strongly affirms the reliability of our calculation results. Second, by applying the same research design again, we investigate the impact of a further reduction in the tick size to $1/100. No such study is available at the moment. The expected changes in the average quoted spreads due to the reduction in the tick size from $1/16 to $1/100, the change through decimalization, range from an increase of 2.82% to a decrease of 15.51%. Derived by applying the same method again, the figures embody a reliable forecast of the real effects and are therefore of eminent importance to academics and to practitioners as well.