The Nasdaq Odd-Eighths Scandal

Before decimalization, US stocks traded in fractions of a dollar — eighths, meaning prices moved in 12.5-cent increments ($10.00, $10.125, $10.25, and so on). In a 1994 academic paper, economists William Christie and Paul Schultz noticed something odd in the way Nasdaq market makers quoted a large number of actively traded stocks: quotes almost never landed on an odd eighth, like $10.125 or $10.375. Prices clustered overwhelmingly on even eighths — quarters and halves — as if the odd increments barely existed.

The reason this mattered is that the minimum spread a market maker could quote was tied to the smallest price increment used. If nobody ever quoted an odd eighth, the effective minimum spread on a stock doubled from one-eighth of a dollar to one-quarter, because the market maker skipped every other available price level. A wider minimum spread means a bigger guaranteed profit on every trade a market maker executes, at the direct expense of the investors on the other side of those trades. Christie and Schultz's statistical analysis found this pattern was far too consistent across dozens of market makers and hundreds of stocks to be a coincidence — it looked like implicit, tacit coordination, an unspoken norm among market makers.

The paper triggered a wave of scrutiny: a Department of Justice antitrust investigation and an SEC investigation followed, along with a wave of academic replication studies confirming the pattern. Nasdaq market makers ultimately settled the DOJ case for a large sum without admitting wrongdoing, and Nasdaq itself paid a substantial SEC penalty over inadequate surveillance of its own market makers' quoting behavior. The direct market-structure consequence was a set of new order-handling rules in 1997 that forced market makers to display customer limit orders and made quote collusion far harder to sustain, and it foreshadowed the move to decimal pricing a few years later, which eliminated the fractional-eighth structure that had made the odd-eighths pattern possible in the first place.

What this means in practice

The odd-eighths episode is one of the clearest documented cases of an entire market's quoted spreads being artificially inflated by a tacit, informal norm rather than by any single firm's individual decision, and it's a foundational case study in how market microstructure research — simply and carefully looking at where prices cluster — can uncover an economically large distortion that no single regulator or trader had flagged on their own. It's also a reminder that "collusion" in market structure doesn't require an explicit agreement; a shared incentive and an unwritten convention that nobody breaks can produce the same effect.