Impact of the tick-size on financial returns and correlations

TL;DR

This paper investigates how the minimum price change (tick-size) influences the distribution of financial returns, correlations, and the Epps effect, providing a model and a correction method for these microstructure impacts.

Contribution

It reveals the significant impact of tick-size on return distributions and correlations, and introduces a method to statistically correct for these effects.

Findings

Tick-size affects the tail behavior of return distributions.

It distorts correlation calculations at small return intervals.

A correction method is proposed to mitigate these effects.

Abstract

We demonstrate that the lowest possible price change (tick-size) has a large impact on the structure of financial return distributions. It induces a microstructure as well as it can alter the tail behavior. On small return intervals, the tick-size can distort the calculation of correlations. This especially occurs on small return intervals and thus contributes to the decay of the correlation coefficient towards smaller return intervals (Epps effect). We study this behavior within a model and identify the effect in market data. Furthermore, we present a method to compensate this purely statistical error.