Changes in Tick Size and Round Lot

CHANGES IN TICK SIZE AND ROUND LOT:

IS IT EFFECTIVE TO INCREASE LIQUIDITY?

Vinardo Rajang, Christiana Fara Dharmastuti

Atma Jaya Catholic University of Indonesia

E-mail: @atmajaya.ac.id

ABSTRACT

The government is authorized in increasing the competitiveness of capital market through increased liquidity and market capitalization. The government has issued a Decree of Stock Exchange Indonesia Directors No. Kep-00071/BEI/11-2013. This study aims at examining the differences in liquidity as measured by Amihud Illiquidity, Amihud Risk, Turnover, Relative Spread, Depth to the Relative Spread, and Waiting Time before and after the change in the tick size and round lot. Test is conducted on daily trading data and daily listed shares which consistently mentioned in LQ45 index of January 2013 - December 2014 trading period.

The study shows that policy changes can improve market liquidity, as measured by 5 liquidity variables which indicates significant changes in amihud Illiquidity, amihud Risk, Relative Spread, Waiting Time and an increase in Depth to Relative Spread. However, Turnover variable experienced insignificant reduction.

Keywords: Liquidity, Tick Size, Amihud Illiquidity, Relative Spread, Waiting Time

Background

Capital market is one means of capital formation and funds allocation which intended to increase community participation in order to support national financial development. The government through Law No. 8, 1995 on the capital markets authorizes PT Indonesian Stock Exchange (BEI), LKP, and LPP as Self-Regulatory Organization (SRO) to establish regulations with approval from Financial Services Authority to manage capital markets become more orderly, fair and efficient (Anwar, 2005, p.173).

In order to improve the liquidity and capitalization of stock market as well as to increase the competitiveness of Indonesia Stock Exchange, on November 8, 2013, BEI issued Decree of the Board of Indonesia Stock Exchange Number Kep-00071 / BEI / 11-2013 which converts Decree Kep-00 399/BEI/11-2012. BEI uses that decree to stipulate the change on Indonesia Bursa Trade Regulations Securities Number II-A on the Equity Trading which applied since January 6, 2014. Changes include round lot, the amount of tick size, and maximum volume of bids and purchase demand for equity trading in the regular market and cash market.

This tick size change policy is not the first time ever conducted by BEI. Referring to the research by Marliyah (2015) the change in tick size described in the table below:

Table 1. Changes of Tick size Before July 3, 2000 until January 6, 2014

Stock Price / Tick Size
Before July 3rd, 2000 / July 3rd, 2000 / October 20th, 2000 / January 3rd, 2005 / January 2nd, 2007 / January 6th, 2014
<IDR 200 / IDR 25 / IDR 5 / IDR 5 / IDR 5 / IDR 1 / IDR 1
IDR 200 - <IDR 500 / IDR 5
IDR 500 - <IDR 2000 / IDR 25 / IDR 10 / IDR 10 / IDR 5
IDR 2000 - <IDR 5000 / IDR 25 / IDR 25
≥ IDR 5000 / IDR 50 / IDR 50 / IDR 50 / IDR 25

Source: Marliyah (2015)

Several previous studies on the impact of changes in round lot and tick size on liquidity show significant differences in all liquidity indicators including decrease in waiting time, volatility and illiquidity ratio and increase in turnover which indicate more liquid market (Chandra, 2015). Research result by Santoso & Mogie (2015) show that there is a significant reduction on the bid-ask spread, depth, and time trading, while trading volume experienced insignificant increase.

Although research on the impact of changes in tick size on liquidity has been frequently conducted, but this research topic is still very interesting to be investigated further. Especially because there are inconsistencies in research results on several variables used. Purwoto & Tandelilin (2004) found a significant decrease in depth to relative spread after change in tick size on July 3, 2000, while Ekaputra & Ahmad (2007) found that a decrease in tick size on January 3, 2005 did not significantly affect average depth to relative spread, but further, Marliyah (2015) investigated the effect of changes in tick size on January 6th, 2014 on liquidity at each price group, found significant decrease in depth to relative spread at group of IDR 200-IDR 500 and IDR 2,000 and IDR 5,000; insignificant increase in depth to relative spread at group price above IDR 5000, and significant increase in depth to relative spread at the group of IDR 500-IDR 2,000.

Trading volume as a measure of market response to market conditions according to Santoso and Mogie (2015) does not significantly increase following changes in round lot and tick size. The gap is also found on researches by Anh, Cai, Chan, and Hamao (2001) on Tokyo Stock Exchange. However, Effendi (2015) and Susanto (2014) found the opposite to that, i.e. changes in round lots and tick size increase trading volume.

The phenomena of policies set by the government which intended to improve market liquidity and the inconsistency on previous studies regarding the effects of government policy changes are interesting to be investigated further, especially on stock liquidity. This study tests liquidity differences measured by Amihud Illiquidity, Amihud Risk, Turnover, Relative Spread, Depth to the Relative Spread, and Waiting Time before and after changes in tick size and round lot. The uniqueness of this study compared to the previous research is that this study usesdiverse liquidity variables include a new additional variable to measure liquidity in better way, which is Amihud Risk. This research uses six liquidity variables: Amihud Illiquidity, Amihud Risk, Turnover, Relative Spread, Depth to the Relative Spread, and Waiting Time with study period one year before and after the change of round lot and the tick size. Diverse variables and longer research period is expected to be able to describe the impact of changes in round lots and tick sizes on liquidity in better way.

THEORETICAL FRAMEWORK

Round lot and Tick size governed by BEI in regulation Number II-A on the Equity Trading. On November 8th, 2013, the BEI made changes to the regulation No. II-A on Equity Trading through decree of the Board of Directors of BEI No. Kep-00071/BEI/11-2013 about change in round lot and tick size. This decree into force on January 6, 2014. The purpose of this change is to increase market liquidity and capitalization and increasing the competitiveness of the exchange. This is because round lot and tick size are component of market microstructure which have important role in improving stock liquidity.

Changes in Round lot

Round lot is the stock round lot that can establish price (Samsul, 2006, p.113). After the enactment of Decree of the BEI Board of Directors No. Kep-00071/BEI/11-2013 on changes in round lot and tick size, the applied round lot is 100 (one hundred) stock equity. Thus, to be able to establish the sale or buy price, investor should sell in full unit lots, i.e. 1 lot = 100 pieces.

Tick Size Changes

Tick size is the set of price change which can form the price. (Samsul, 2006, p.114). After the enactment of the Decree of Director Board of BEI No. Kep-00071/BEI/11-2013 about change in unit trade and tick size, the applied tick size is as follows

Table 2. Change in Tick size

Before / After
Price Group / Tick Size / Price Group / Tick Size
IDR 200 / IDR 1 / IDR 500 / IDR 1
IDR 200-<IDR 500 / IDR 5
IDR 500-<IDR 2000 / IDR 10 / IDR 500-<IDR 5000 / IDR 5
IDR 2000-<IDR 5000 / IDR 25
≥IDR 5000 / IDR 50 / ≥IDR 5000 / IDR 25

Source: BEI

Liquidity

Stock liquidity according to Bodie, Kane, and Marcus (2013, P.55) is the ability to trade asset at a reasonable price in easy and fast way. Speed of security can be traded in the secondary market shows risk liquidity. The faster a security traded, more liquid the security (Tandelilin, 2001, P.50). Wyss (2004) suggests five levels of liquidity, namely: a) Ability to trade b) Trading with price impact c) Trading without price impact d) Buying and selling at about the same price e) Immediate Trading.

Further stated by Wyss (2004), four aspects or liquidity dimensions, including:

1. Trading time: The ability to execute transactions immediately at applied price.

2. Tightness: The ability to buy and sell an asset at the same price in the same time.

3. Depth: The ability to buy or sell a number of assets without affecting quoted price.

4. Resiliency: The ability to buy or sell a number of assets with small influence on quoted price.

Harris (2002, p.6-3) stated that the impact of the increase in the minimum price (tick) on price competition is distinguished by tick size. If the tick size is too small, it reduces price competition by the weakening of time precedence rule. If the tick size is too big, traders are reluctant to trade because it is expensive. Thus the tick size affects the willingness investors or traders in the transaction, then tick size affects liquidity.

Chandra (2015) showed significant difference from all the liquidity indicators: decrease in waiting time, volatility and illiquidity ratio and increase in turnover, indicating more liquid market. Santoso & Mogie (2015) examined bid-ask spread, depth, trading volume and trading time as the variables of stock liquidity which indicates that there is significant decline in bid-ask spread, depth, and time trading, while increase in trading volume is insignificant. Marliyah (2015) showed that decrease in tick size has positive influence on relative spread and depth. To resolve results contradiction, calculation of depth to relative spreads showed decrease in tick size can only improve stock liquidity in price group of IDR 500- IDR 2,000.

While Ekaputra & Ahmad (2007) conducted a study on the impact of tick size reduction on liquidity and order strategy in the Jakarta Stock Exchange in 2005, the results showed that the bid-ask spread decreased significantly, which means liquidity increased from the aspect of width and immediacy cost but from liquidity is decreased in the standpoint of bid-ask depth. To resolve the conflicting results, ratio of average depth to relative spread (DRS) is used. Studies on the change in tick size on July 3rd, 2000 in Jakarta Stock Exchange conducted by Purwoto & Tandelilin (2004), with research results showed that the rupiah spread, percentage spread and depth experience decreased significantly. But all sizes of trading activity such as number of trades, share volume, and the rupiah volume increased in low-priced stocks, and otherwise trading activity declined in high-priced stocks.

In this study researchers identified six related hypotheses to observe the difference of variable liquidity through Amihud Illiquidity, Amihud Risk, Turnover Relative Spread, Depth to the Relative Spread, and Waiting Time after the change in round lot and the tick size. Amihud Illiquidity is a measure which reflect the impact of the transaction on prices. Lower the impact of the transaction to the price, more liquid the stock (Amihud, 2002). This measurement is used to count the impact of transaction price. The measurement refers to the study by Goyenko, Holden, & Trzcinka (2009) which found that Illiquidity Amihud (2002) can measure the price impact well. In Wyss (2004), the liquidity ratio used is Amihud (2002) referred to as multi-dimensional liquidity measure, which is a measure of liquidity that combines more than one-dimensional measure liquidity.

H1: There is significant decrease in the Amihud Illiquidity variable after the changes in round lot and tick size.

Standard deviation can describe the risks or deviations. Therefore, the standard deviation of Amihud Illiquidity can describe fluctuations of liquidity. Liquidity continues to change over time, meaning that there is uncertainty how much costs that will be incurred when an investor wants to sell its stock in the future. Low liquidity fluctuation describes more liquid stocks. (Aji, 2012)

H2: There is significant reduction in Amihud Risk variable after the changes in round lot and tick size.

Turnover describes transactions activities which is trading volume. Greater the turnover value, more liquid the stock. (Aji, 2012)

H3: There is significant increase in the Turnover variable after the changes in round lot and tick size.

Relative Spread describes the transaction cost and immediacy cost. Difference between the Bid and Ask and associated calculations may provide estimated expenses to be incurred at the time of transaction. In addition to the cost and tax, the investor must pay the spread as fees for execution transaction immediately (Wyss, 2004). Therefore, smaller the Relative Spread show more liquid stock.

H4: There is a significant decrease in Relative Spread variable after the changes in round lot and tick size.

Depth describes the volume traded on the bid and ask prices. Stocks with large Depth is more liquid as it is able to absorb higher transaction values before it affects the price. Depth to the Relative Spread measured whether the decline is greater or smaller than the decline in Relative Spread (Ekaputra & Ahmad, 2007). Greater depth to the Relative Spread show more liquid stock.

H5: There is a significant decrease in the Depth to the Relative Spread variable after the changes in round lot and tick size.

Waiting Time is a measurement related to time. This size illustrates how frequent the transactions happened. More frequent the transactions made, indicate more liquid stock (Wyss, 2004). Less waiting time indicates more liquid market.

H6: There is significant decrease in Waiting Time variable after the changes in round lot and tick size.

Research model illustrates whether there are differences in liquidity before and after the changes in round lot and tick size.

Figure 1. Research Model

Before / Changes in
Tick Size
And
Round Lot / After
Amihud Illiquidity / Amihud Illiquidity
Amihud Risk / Amihud Risk
Turnover / / / Turnover
Bid-Ask Spread / Bid-Ask Spread
Depth to Relative Spread / Depth to Relative Spread
Waiting Time / Waiting Time

RESEARCH METHODS

Research data is the processed data from daily trading and daily listed shares obtained from PT Indonesia Capital Market Electronic Library (ICaMEL). The consistent daily stock data company entered in LQ45 index in January 2013 - December 2014 trading period. Based on several criteria and fulfillment of normality test, obtained 22 stocks data that is used in this study.

Operational Definition of Variables

Amihud Illiquidity, reflects the impact of the transaction on prices. Lower the impact of transaction on prices, more liquid the shares. (Amihud, 2002)

Amihud Risk, shows standard deviation of Amihud Illiquidity which depicting fluctuations of liquidity. Low liquidity fluctuation shows more liquid stock. (Aji, 2012)

Turnover, describes the transaction activity, which is trading volume. Greater the Turnover value, more liquid the stock. (Aji, 2012)

Relative Spread, describes the transaction cost and immediacy cost. Difference between Bid and Ask and associated calculations can provide the estimated expenses to be incurred at the time of the transaction (Wyss, 2004)

Depth to the Relative Spread, describes the volume traded with the bid and ask price. Stocks with great value of Depth is considered more liquid because it can absorb higher value of transactions before affecting the price. Depth to Relative Spread measures whether the decline in Depth is greater or smaller than the decline in Relative Spread (Ekaputra & Ahmad, 2007).

Waiting Time, size associated with time. This measurement illustrates how frequent the transaction is done. More often transaction shows more liquid (Wyss, 2004). Greater frequency means less waiting time is needed, thus indicating more liquid market.

DATA ANALYSIS

In testing the hypothesis, it is important to conduct normality test using Lilliefors (Kolmogorov-Smirnov) in order to obtain normally distributed data so can be tested in pairs (Paired sample T-test). Based on normality test, variables studied including Amihud Illiquidity, Amihud Risk, Turnover, Relative Spread, Depth to Relative Spread, Waiting Time have greater p-value than α of 0.05 for the data before and after the policy change, so data comes from normally distributed population.

Table 3. Amihud Illiquidity Descriptive

Table 4. Paired-Samples T Test of Amihud Illiquidity variable

Source: Data processing using IBM SPSS 22

P-value for one-sided test is smaller than α of 0.05. so hypothesis is accepted, there is significant decrease in Amihud Illiquidity variable after the implementation of changes in round lot and tick size. Average decline on Amihud Illiquidity from 0.0000003795 in the period before new rule changed to 0.0000002927 in the period after new rule, shows that changes in prices and round lot is able to minimize price impact resulting from a transaction. The change in unit trade and tick size simultaneously able to drive the market to absorb transactions without making large price impact. Decrease in Amihud Illiquidity occurs due to a decrease in tick size that makes the price change becomes more smooth and closer to the actual market value, so investors are able to absorb the transaction before it affects the price. These results are consistent with research by Chandra (2015), which also found significant decrease in Amihud Illiquidity variable which indicates that the market is more liquid.

Table 5. Amihud Risk Descriptive

Table 6. Paired-Samples T Test on Amihud Risk variable

Source: Data processing using IBM SPSS 22

P-value for a one-sided test is smaller than α of 0.05. So, hypothesis is accepted that there is significant decrease in Risk Amihud variable after the implementation of changes in round lots and tick size. Liquidity is constantly changing over time, therefore, uncertainty is raised on how much the costs when an investor wants to sell his stock in the future (Aji, 2012). Considering this phenomenon, the calculation of liquidity fluctuations measured by standard deviation of Amihud Illiquidity variables. As a result, decrease in Amihud Risk from 0.0000003807 before the change into 0.0000002783 after the change. Decrease in Amihud Illiquidity indicating more liquid market, and supported by decrease in Amihud Risk. Decrease in Amihud Risk is due to decrease in tick size, making price movement becomes more smooth and closer to the actual market value so that in the end, decreasing the fluctuations of liquidity. This phenomenon indicates less risk suffered by investors when they want sold their stocks in the future.