Chapter 14
The Impact of Reducing Tick Size
on Malaysian ’ s Stock Market Liquidity
Diana Baharuddin, Imbarine Bujang and Hamizah Hassan
Abstract This paper provides a unique opportunity to investigate the impact reduction in tick size towards Malaysian’s stock market liquidity by utilising spread and trading volume as proxies to market liquidity. The main function of tick size it is a tool to improvise the market liquidity, it is a tool to beautify the market liquidity. Using the components of FTSE-BMKLCI and closing daily data com- piled starting from the implementation new tick size regime, from 3 August 2009 until the end of trading day 31 December 2014, this study found that, with the reduction in tick size, it reduces the spread significantly and there is a significant impact on trading volume.
Keywords Liquidity
Tick sizeSpread Trading volumetrading in Bursa Malaysia to improve the market liquidity (Taunson and Poshakwale2014). By using smaller tick size, Bursa Malaysia (2009) believes that it could strengthen the market complexity and improve the liquidity among traders.
A question that arises is how to beautify the market liquidity. Kadan (2006) mentioned that one of the policy tools that can be used by thefinancial market to enhance market liquidity is by using tick size. He further argued that reducing the tick size could enhance the market liquidity and increase the gains traded in the market,1particularly for stock exchanges. Bursa Malaysia (2009) defines tick size or minimum bid as the minimum price variation between the buying and selling price for a stock.2 Table14.1 summarises tick size differentiations pre- and post-implementation of the new tick size structure from different price ranges.
This topic has drawn significant interest to the market exchangers and aca- demicians from all over the world in investigating the consequences of using smaller tick size on market liquidity. Evidence can be found from Australia (Aitken and Forde2005), the USA (Ahn et al. 1996; and Goldstein and Kavajecz2000), Japan (Ahn et al. 2007), Singapore (Lau and Mclnish1995), Thailand (Pavabutr and Prangwattananon2009), Indonesia (Allen and Sudiman2009) and Hong Kong (Gerace and Smark2012). One motivation to conduct this research is the paucity of research investigating the impact of a reduction in tick size on market liquidity in the Malaysian stock market.
Table 14.1 Structure of pre-
and post-changes in tick size Stock price range Tick size (Cent)
Pre Post
Below RM1.00 0.50 0.50
RM1.00–RM2.99 1 1
RM3.00–RM4.99 2 1
RM5.00–RM9.99 5 1
RM10–RM24.99 10 2
RM25.00–RM99.98 25 2
RM100.00 and above 50 10
Note For bonds, debentures, warrants and call warrants, the minimum bid structure will have the same minimum trading spreads as for shares. Tick size for different price ranges are shown before (pre) and after (post) 3 August 2009, which became the new rule of minimum price range and effectively on Bursa Malaysia
1Harris (2002) found that liquidity derives from different perspectives such as traders need liq- uidity to encourage them implement inexpensive trading strategies, exchanges need liquidity to fascinate traders to commerce with them and regulators fancy liquidity as the liquid market will produce less volatility.
2Harris (1997) delineates tick size as minimum price increment at what prices traders use.
Meanwhile, Pavabutr and Prangwattananon (2009) define tick size as minimum price changes allowed for stock quotations.
The trend to use smaller tick size in trading mechanisms has created dozens of
“natural experiment”that attempt to reduce transactions cost (spread) and promote trading activities. Harris (1994) mentioned that a larger tick size increases the exe- cution cost (bid–ask spread) because tick size and bid–ask spread are binding con- straints and impose unnecessarily large execution cost. In simple terms, using large tick size could increase the cost, whereas using smaller tick size might reduce the incentive for traders. Harris (1994) also concludes that smaller tick size would sig- nificantly reduce the spread. This means that implementing the use of smaller tick size is expected to reduce the cost to attract more traders to provide liquidity. Krishnan and Mishra (2013) found that trading volume could become an indicator of liquidity, as a higher volume of trade is a sign of high liquidity. However, according to Pavabutr and Prangwattananon (2009), a well-known result when investigating the impact of using smaller tick size is lower spreads and the impact on trading volume to increase trading activities remains uncertain. Nevertheless, most researchers documented that reduc- tions in tick size does not increase volume to a statistically significant extent (Ahn et al.
2007; Aitken and Forde2005; Bacidore1997; Huson et al.1997). However, a recent paper by Gerace and Smark (2012) provides evidence of an increase in trading volume when the Hong Kong Stock Exchange (HKEx) reduced the minimum tick size.
Taunson and Poshakwale (2014) examined the post-changes or the reduction in tick size using data from Malaysia. Their analysis used trading volume as an indicator to measure the market liquidity. Theirfindings revealed that as tick size decreases, it has a positive impact on pricing efficiency by using future index data and hence improves the effectiveness of index futures. However, as they use trading volume as a proxy to liquidity, they found that the coefficient of tick size and trading volume is negative, and increases the volume traded, yet the regression coefficient is not sta- tistically significant. This result reveals that the reduction in tick size and whether it enhances the market liquidity or vice versa in the context of the Malaysian stock market are still ambiguous.
Prior to the reduction in tick size in Malaysia, Chung et al. (2005) examined the structure of tick size using data from Bursa Malaysia. They investigated the ability of using seven different tick sizes from Bursa Malaysia and utilised spread and depth as proxies of liquidity. From their empirical findings, they suggested that KLSE’s stepwise tick system unnecessarily executes large execution cost to higher priced stocks and stocks that have larger tick size binding constraints to a larger spread. In short, their results suggest that larger tick size for higher stock prices are damaging to market liquidity. Considering the conclusions of Taunson and Poshakwale (2014) and Chung et al. (2005), the question could arise as to what happens to the market liquidity after the market exchanger implements the new tick size regime by taking into con- sideration the spread and trading volume as indicators for market liquidity. Does the market liquidity become liquid? Are the spread and tick size binding constraints even using daily data? Is the trading volume statistically significant when tick size is smaller? To provide an answer to these questions, this study investigates the impact of a reduction in tick size towards market liquidity in the Malaysian stock market by employing trading volume and spreads as proxies to market liquidity as well as using
14 The Impact of Reducing Tick Size… 147
components of the FTSE Bursa Malaysia Composite Index (FTSE-BMKLCI) as the sample of study.
This paper divides into five sections. The next section explains the impact reduction in tick towards market liquidity by using spread and trading volume as their proxies to liquidity. Section three explains the description of dataset and measurement of the dataset used in this study. Section four presents the results, and thefinal section provides concluding remarks.