DP1717 Minimum Price Variations, Time Priority and Quote Dynamics

Author(s): Tito Cordella, Thierry Foucault
Publication Date: October 1997
Keyword(s): Market-Microstructure, Quote Formation, Tick Size, Time Priority, Trading Costs
JEL(s): D43, G10
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1717

This paper analyses the impact of a minimum price variation (tick) and time priority on the quote dynamics and on trading costs when competition for the order flow is dynamic. It finds that convergence to competitive prices can take time and that the speed of convergence is influenced by the tick size, the priority rule and the characteristics of the order arrival process. It also shows that a zero minimum price variation is never optimal when competition for the order flow is dynamic. The paper compares the trading outcomes with and without time priority. It shows that, for reasonable parameterizations, time priority reduces trading costs because it prevents equilibria in which uncompetitive spreads can be sustained. Finally, the paper relates (a) the trading costs to the speed with which liquidity suppliers react to their competitors? offers and (b) the dynamics of the best price in the market to the state of the book.