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A Minimum Increment Solution

Traders Magazine, October 2003

William G. Christie

What a difference a decade makes! In the mid-1990's, there was a very public controversy over the inside spread on Nasdaq stocks. Professor Paul Schultz and I suggested in 1994 that Nasdaq market makers were maintaining spreads that were "too wide." That's because the inside spreads on the most active issues were bouncing between $0.25 and $0.50 per share. It was due to the avoidance of odd-eighth quotes. Nevertheless, legal and regulatory pressure - including the order handling rules - eventually ensured that individual and institutional investors were no longer subject to a lack of competition among market makers. Now, about 10 years later, the pendulum has swung 180 degrees. Market participants and regulators are debating whether spreads are "too small" in a penny environment. The guiding logic in switching to pennies was that the market should determine the equilibrium inside spread for each issue based on its price, volatility, volume, degree of private information and other factors. It was a case of reducing the tick size to a penny for all stocks, and the invisible hand of the market would ensure that each issue trades at a competitive inside spread.

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