Hostname: page-component-84b7d79bbc-lrf7s Total loading time: 0 Render date: 2024-07-29T16:13:17.208Z Has data issue: false hasContentIssue false
  • English
  • Français

Tick Size and Institutional Trading Costs: Evidence from Mutual Funds

Published online by Cambridge University Press:  06 April 2009

Nicolas P. B. Bollen  and
Jeffrey A. Busse
Nicolas P. B. Bollen
Affiliation:
nick.bollen@owen.vanderbilt.edu, Owen Graduate School of Management, Vanderbilt University, 401 21st Ave S, Nashville, TN 37240
Jeffrey A. Busse
Affiliation:
jeff busse@bus.emory.edu, Goizueta Business School, Emory University, 1300 Clifton Rd, Atlanta, GA 30322.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper measures changes in mutual fund trading costs following two reductions in the tick size of U.S. equity markets: the switch from eighths to sixteenths and the subsequent switch to decimals. We estimate trading costs by comparing a mutual fund's daily returns to the daily returns of a synthetic benchmark portfolio that matches the fund's holdings but has zero trading costs by construction. We find that the average change in trading costs of actively managed funds was positive following both reductions in tick size with a larger and statistically significant increase following decimalization. In contrast, index fund trading costs were unaffected.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 41 , Issue 4 , December 2006 , pp. 915 - 937
Copyright
Copyright © School of Business Administration, University of Washington 2006

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Ahn, H.; Cao, C.; and Choe, H.. “Decimalization and Competition among Exchanges: Evidence from the Toronto Stock Exchange Cross-Listed Securities.” Journal of Financial Markets, 1 (1998), 51–87.CrossRefGoogle Scholar
Angel, J. “Tick Size, Share Prices, and Stock Splits.” Journal of Finance, 52 (1997), 655–681.CrossRefGoogle Scholar
Anshuman, R., and Kalay, A.. “Market Making with Discrete Prices.” Review of Financial Studies, 11 (1998), 81–109.CrossRefGoogle Scholar
Bacidore, J. “The Impact of Decimalization on Market Quality: An Empirical Investigation of the Toronto Stock Exchange.” Journal of Financial Intermediation, 6 (1997), 92–120.CrossRefGoogle Scholar
Bacidore, J.; Battalio, R.; and Jennings, R.. “Order Submission Strategies, Liquidity Supply, and Trading in Pennies on the New York Stock Exchange.” Journal of Financial Markets, 6(2003), 337–362.CrossRefGoogle Scholar
Barber, B., and Odean, T.. “Online Investors: Do the Slow Die First?” Review of Financial Studies, 15 (2002), 455–487.CrossRefGoogle Scholar
Beneish, M., and Whaley, R.. “S&P 500 Index Replacements: A New Game in Town.” Journal of Portfolio Management, 29 (2002), 1–10.CrossRefGoogle Scholar
Bessembinder, H. “Trade Execution Costs and Market Quality after Decimalization.” Journal of Financial and Quantitative Analysis, 38 (2003), 747–777.CrossRefGoogle Scholar
Blake, C.; Elton, E.; and Gruber, M.. “The Performance of Bond Mutual Funds.” Journal of Business, 66 (1993), 371–403.CrossRefGoogle Scholar
Bollen, N., and Busse, J.. “Short-Term Persistence in Mutual Fund Performance.” Review of Financial Studies, 18 (2005), 569–597.CrossRefGoogle Scholar
Bollen, N., and Whaley, R.. “Are ‘Teenies’ Better?” Journal of Portfolio Management, 24 (1998), 10–24.CrossRefGoogle Scholar
Brown, K.; Harlow, W.; and Starks, L.. “Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry.” Journal of Finance, 51 (1996), 85–110.CrossRefGoogle Scholar
Brown, S.; Laux, P.; and Schacter, B.. “On the Existence of Optimal Tick Size.” Review of Futures Markets, 10 (1991), 50–72.Google Scholar
Carhart, M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Carhart, M.; Kaniel, R.; Musto, D.; and Reed, A.. “Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds.” Journal of Finance, 57 (2002), 661–693.CrossRefGoogle Scholar
Chakravarty, S.; Panchapagesan, V.; and Wood, R.. “Did Decimalization Hurt Institutional Investors?” Working Paper, Purdue University (2004).Google Scholar
Chakravarty, S.; Wood, R.; and Van Ness, R.. “Decimals and Liquidity: A Study of the NYSE.” Journal of Financial Research, 27 (2004), 75–94.CrossRefGoogle Scholar
Chalmers, J.; Edelen, R.; and Kadlec, G.. “On the Perils of Financial Intermediaries Setting Security Prices: The Mutual Fund Wild Card Option.” Journal of Finance, 56 (2001a), 2209–2236.CrossRefGoogle Scholar
Chalmers, J.; Edelen, R.; and Kadlec, G.. “Fund Returns and Trading Expenses: Evidence on the Value of Active Fund Management.” Working Paper, University of Oregon (2001b).Google Scholar
Chan, L., and Lakonishok, J.. “The Behavior of Stock Prices around Institutional Trades.” Journal of Finance, 50 (1995), 1147–1174.CrossRefGoogle Scholar
Chiyachantana, C.; Jain, P.; Jiang, C.; and Wood, R.. “International Evidence on Institutional Trading Behavior and Price Impact.” Journal of Finance, 59 (2004), 869–898.CrossRefGoogle Scholar
Fama, E., and French, K.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Goldstein, M., and Kavajecz, K.. “Eighths, Sixteenths, and Market Depth: Changes in Tick Size and Liquidity Provision on the NYSE.” Journal of Financial Economics, 56 (2000), 125–149.CrossRefGoogle Scholar
Grinblatt, M., and Titman, S.. “Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings.” Journal of Business, 62 (1989), 393–415.CrossRefGoogle Scholar
Grinblatt, M., and Titman, S.. “Performance Measurement without Benchmarks: An Examination of Mutual Fund Returns.” Journal of Business, 66 (1993), 47–68.CrossRefGoogle Scholar
Harris, L. “Stock Price Clustering and Discreteness.” Review of Financial Studies, 4 (1991), 389–415.CrossRefGoogle Scholar
Harris, L. “Minimum Price Variations, Discrete Bid-Ask Spreads, and Quotation Sizes.” Review of Financial Studies, 7 (1994), 149–178.CrossRefGoogle Scholar
Investment Company Institute. “2003 Mutual Fund Fact Book.” Washington, DC: Investment Company Institute (2003).Google Scholar
Jensen, M. “The Performance of Mutual Funds in the Period 1945–1964.” Journal of Finance, 23 (1968), 389–416.Google Scholar
Jones, C., and Lipson, M.. “Sixteenths: Direct Evidence on Institutional Execution Costs.” Journal of Financial Economics, 59 (2001), 253–278.CrossRefGoogle Scholar
Keim, D., and Madhavan, A.. “Transactions Costs and Investment Style: An Inter-Exchange Analysis of Institutional Equity Trades.” Journal of Financial Economics, 46 (1997), 265–292.CrossRefGoogle Scholar
Nasdaq Economic Research. “The Impact of Decimalization on the Nasdaq Stock Market: Final Report to the SEC.” (06 11, 2001).Google Scholar
NYSE Research Division. “Decimalization of Trading on the New York Stock Exchange: A Report to the Securities and Exchange Commission.” (09 7, 2001).Google Scholar
Porter, D., and Weaver, D.. “Decimalization and Market Quality.” Financial Management, 26 (1997), 5–26.CrossRefGoogle Scholar
Ronen, T., and Weaver, D.. “‘Teenies’ Anyone?” Journal of Financial Markets, 4 (2001), 231–260.CrossRefGoogle Scholar
Seppi, D. “Liquidity Provision with Limit Orders and a Strategic Specialist.” Review of Financial Studies, 10 (1997), 103–150.CrossRefGoogle Scholar
Stoll, H. “Market Microstructure.” In Handbook of the Economics of Finance, Constantinides, G., Harris, M., and Stulz, R., eds. Amsterdam, The Netherlands: North-Holland Publishing (2002).Google Scholar
Wermers, R. “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses.” Journal of Finance, 55 (2000), 1655–1695.CrossRefGoogle Scholar
Wermers, R. “The Potential Effects of More Frequent Portfolio Disclosure on Mutual Fund Performance.” Investment Company Perspective, 7 (2001), 1–11.Google Scholar
Werner, I. “Execution Quality for Institutional Orders Routed to Nasdaq Dealers before and after Decimals.” Working Paper, Ohio State University (2003).CrossRefGoogle Scholar
Zitzewitz, E. “Who Cares about Shareholders? Arbitrage-Proofing Mutual Funds.” Journal of Law, Economics, & Organization, 19 (2003), 245–280.CrossRefGoogle Scholar