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This study suggests that the change of tick size, particularly in a step-function tick system, accounts for cross-sectional variation in market liquidity. We explored the relative significance of commonality in liquidity in a limit order book during the period of tick-size conversion, and empirically examined the interactions of inventory risk and asymmetric information on liquidity co-movements. We observed that market-wide and within-industry commonality in liquidity is ubiquitous before and after tick-size conversion. Moreover, the small spreads and thin limit order book introduced by the narrowed minimum price variation further strengthened liquidity co-movements. We also observed that trade size and trading frequency exhibited significantly negative influences on spread measures before and after tick-size conversion, whereas significantly positive effects persisted for depth constructs. Finally, we documented affluent industry-wide liquidity co-movements before and after tick-size conversion, after accounting for marginal influences of potent idiosyncratic liquidity determinants including volatility, market price, and trade volume. Our empirical evidence reveals that a narrow tick size might generate considerable market-wide liquidity risk and produce adverse effects on market quality.

Tick Size and Commonality in Liquidity