Removing share trading minimum reduces costs

02 December 2015

  • Stock exchanges could reduce costs by removing minimum lot size rules
  • More retail traders would take part if minimum lot size was abolished
  • Italian stock exchange saw retail traders increase by 16 per cent
  • Borsa Italia also improved liquidity when minimum size removed

Stock exchanges that remove constraints on their minimum lot size - or Minimum Trading Unit (MTU) - increase retail trader participation and reduce transaction costs, according to new research.

While most European stock exchanges now have a MTU of one share, a number of important stock exchanges, including the NYSE, the NASDAQ and the Tokyo Stock Exchange, still set higher MTUs, which are decided at the discretion of the exchanges or, in some instances, by the issuing companies.

Researchers from Warwick Business School, Bath School of Management and Bocconi University, studied the impact on market quality of reducing the MTU to one share at the Italian Stock Exchange, the Borsa Italiana, in 2002.

In their paper Lot Size Constraints and Market Quality: Evidence from the Borsa Italiana, published in Financial Management, they show that the change in the MTU resulted in a substantial improvement in liquidity. Notably, the relative bid-ask spread - essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it - decreased, on average, by 10.2 per cent in the month after the event.


Borsa Italiana
Image: Stefano Petroni Flickr
Better off: The Borsa Italiana in Milan that has reduced transactional costs by removing the minimum lot size


Arie Gozluklu, Assistant Professor of Finance at Warwick Business School, said: "The evidence from the Italian market shows that stock exchanges are better off removing a trading constraint imposed on retail traders with a limited budget. Thus, exchanges will allow a wider participation to the stock market in a fair trading environment."

The study also found that liquidity improvement was sustained in the following months and was more significant for stocks with a higher volume of trading at a size equal to the MTU before the MTU reduction.

The researchers documented an increase in retail trading participation around the MTU change, as measured, among other methods, by a 16 per cent increase in online trading in the month after the reduction. They interpret their results in light of a theoretical model where market participants have different levels of private information and the MTU affects traders' choice of order size.

Improving liquidity

Pietro Perotti, lecturer in Accounting & Finance at Bath School of Management, said: "Constraints on the MTU may facilitate exchange operations. However, removing these constraints encourages the participation of retail traders who would not be able to trade at a size larger than the MTU. As a consequence of the increase of trading by retail investors, which is unrelated to private information, adverse selection costs decrease and liquidity increases.

"Our results inform market regulators and participants on how the MTU design may affect market quality. The topic is particularly relevant because the average transaction size significantly decreased in recent years. Stock exchanges with MTU constraints may consider our results as strong evidence supporting a decision to remove or weaken the constraints."

Arie Gozluklu teaches Asset Pricing on the part-time MSc Finance taught at WBS London at The Shard. He also teaches Asset Pricing and Investments on the MSc Finance & Economics, and International Financial Management on the MSc Finance and Warwick Business School's Undergraduate programme.


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