The Tick Size Pilot And What It Showed

After decimalization in 2001 let stocks quote in one-cent increments, small-cap stocks saw spreads compress and some observers worried this had hurt liquidity for less-traded names — with pennies as the minimum increment, market makers might have less incentive to post large size at any one price because the profit per trade shrank. The SEC's Tick Size Pilot, run from 2016 to 2018, tested this directly by taking about 1,200 small-cap stocks and forcing a random subset to quote and trade in five-cent increments instead of one cent, while a control group kept trading in pennies.

What the experiment measured

Because stocks were randomly assigned to test groups and a control group, researchers could compare spreads, quoted depth, and trading costs across groups that were similar in every other respect, isolating the effect of tick size itself rather than confounding it with the many other differences between stocks. The pilot had several groups: some just widened the quoting increment, and others additionally required trades to occur in five-cent increments too (with limited exceptions), or added a "trade-at" rule requiring venues to either match the best quote or provide meaningful price improvement.

What it found

Quoted spreads widened substantially in the wider-tick groups, exactly as mechanically expected — you can't display a narrower spread than the tick allows. But quoted depth at the best price also increased, since a wider mandatory increment made it more attractive to post larger size there rather than get outbid by a one-cent step. The more contested finding was on trading costs: for many stocks, effective costs for retail-sized trades appeared to rise rather than fall, since investors were now forced to cross a wider minimum spread even though more size was available at that price — depth improved, but at a real cost to takers.

What this means in practice

The pilot became a widely cited natural experiment in market microstructure research precisely because true randomized trials are rare in market design — most tick-size debates before and since rely on comparing different stocks or different eras, which brings in confounding factors the pilot avoided. Its mixed results (wider spreads and more depth, but not clearly better outcomes for small investors) are a standard reference point whenever regulators or exchanges propose changing tick sizes again, and a case study in how a market-design change can help one dimension of quality while hurting another.