The impact of a tick size reduction in Futures Markets: evidence from the Sydney Futures Exchange

Abstract

This dissertation examines the impact of a reduction in the minimum price increment on market quality and price impact in the 3 Year Commonwealth Treasury Bond Futures contract. Prior to the tick size reduction, the minimum tick was one basis point. However, as of December 15, 2006, the minimum price increment was reduced to half a basis point. Using two data sets, the first provided by SIRCA and the second a proprietary data set provided by the Sydney Futures Exchange, this study is the first to examine how a reduction in minimum tick affects both market quality and price impact in a futures market setting. This thesis contributes to, and extends, the literature on minimum tick size reductions in several ways. First, this thesis extends the tick size literature into futures markets. Second, the proprietary data set allows an analysis of how the reduction in tick size affects the price impact of institutional trade packages. Finally, this dissertation is the first tick size study to consider both the seasonality in bond futures trading as well as the virtual round-the-clock trading of futures. Results indicate that bid-ask spreads and quoted depth are significantly reduced after the tick reduction. While the price impact of small trades is insignificantly different from zero in all periods examined, after the tick size reduction, large trade packages experience reductions in price impact. These findings suggest that overall market quality has improved after the reduction in minimum tick. The improvements in market quality are isolated to the 3 year bond futures contract, with minimal variations in control contracts. Robustness tests isolate market quality improvements to the 3 year bond futures and attribute the improvement to the reduction in minimum tick.