Journal article
Inverted fee structures, tick size, and market quality
C Comerton-Forde, V Grégoire, Z Zhong
Journal of Financial Economics | Elsevier | Published : 2019
Abstract
Stock exchanges compete for order flow through their fee models. A traditional model pays rebates to liquidity suppliers, and an inverted model pays rebates to liquidity demanders. Using a regulatory intervention to examine the interaction between tick size, restrictions on dark trading, and exchange fees, we show that traders use inverted venues to adjust for suboptimal tick sizes. Increased inverted venue activity improves pricing efficiency and liquidity, especially when the tick size is binding. We show that the sub-tick price improvement offered by inverted venues enhances competition for liquidity provision and increases information impounded into prices through nonmarketable limit ord..
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Funding Acknowledgements
We thank Bill Schwert (the editor), the anonymous referee, Pat Akey, James Brugler, Sabrina Buti, Terry Hendershott, Andrei Kirilenko, Katya Malinova, Charles Martineau, Maureen O'Hara, Andreas Park, Steven Riddiough, Barbara Rindi, Gideon Saar, David Schumacher, Andriy Shkilko, Peter Swan, Ingrid Werner, Mao Ye, Bart Yueshen, as well as seminar participants at University of Melbourne, Queensland University of Technology, Monash University, McGill, HEC Montreal, University of Toronto, Deakin University, University of Sydney, the 2017 SHoF Fintech conference, NFA 2017, FIRN 2017, and AFA 2018 for helpful comments and suggestions. We thank the Securities Industry Research Center of Asia-Pacific (SIRCA) for providing access to Thomson Reuters Tick History and NASDAQ for providing access to the ITCH data. Most of the research was done while Gregoire and Comerton-Forde were affiliated with the University of Melbourne. Comerton-Forde is an economic consultant on market structure for the Australian Securities and Investments Commission and has received research support from the Norwegian Finance Initiative.