Minimum Price Variations, Time Priority and Quote Dynamics

Abstract

We analyze price competition between dealers in a security market where the bidding process is sequential. The model provides an interpretation for the evolution of the best ask and bid prices, in-between transactions. We find that convergence to the competitive ask and bid prices can take time. The speed of convergence is determined by the frequency with which dealers check their offers and the tick size. This creates a relationship between the expected trading cost and the timing of offers posted by the dealers. We also obtain that a zero minimum price variation never minimizes the expected trading cost. In fact, the optimal tick size increases with the level of the monitoring cost borne by the dealers. Finally, we find that time priority prevents dealers from using bidding strategies sustaining a non-competitive price for a long time.

JEL Classification: G19, D43