Is Penny Trading Optimal for Closed-end Funds in China?

for their helpful comments and research support. The comments and point of views expressed in the paper, however, are the authors own, and do not necessarily reflect the opinions of the New York Stock Exchange and the Shanghai Stock Exchange. Therefore, the authors are responsible for all remaining errors. Abstract This paper studies the impact of the minimum price variation (tick size) on closed-end fund trading in the Chinese stock market. The current tick size for the closed-end funds is ¥0.01 at the Shanghai and Shenzhen stock exchanges. With the average market prices for the funds around ¥1.00, the penny tick size is relatively large and approximately 1% of the funds' value. We find the penny tick size is binding and limits the price competition. The bid-ask spread is almost unchanging during a trading day and equal to the tick size. In addition, the large tick size distorts the normal trading pattern for securities. We find that the quotes for the funds are highly inactive and the average quoted depth is surprisingly large. We also find that the limit order fill rate (open rate) for closed-end funds is much lower (higher) than that of stocks. In particular, large orders tend to enter into the book in the early morning and act as " voluntary market makers. " Finally, we study policy implications. Our evidence supports that the penny tick size is not optimal for trading closed-end funds in China. It makes demanding immediacy expensive, and discourages investors to trade through marketable limit orders, resulting a less liquid market. It also negatively affects the social welfare in the Chinese stock markets: it induces large investors to act as " market makers of a day " and increases trading cost for small investors. We propose using one tenth of a penny as the tick size to trade closed-end funds in the Chinese stock market.