THE EFFECT OF TRADING IN EIGHTHS ON SECURITY RETURN BEHAVIOR

Robert W. Ingram, Mary S. Stone, Michael Timothy Dugan

Research output: Contribution to journalArticle

Abstract

Currently the equity securities of most British, Canadian and US firms trade in eighths. However, this pricing system may soon be abandoned in the US. Specifically, the US Securities and Exchange Commission (SEC) is currently studying the feasibility of changing the pricing of US securities to dollars and cents from dollars and eighths. ‘SEC officials contend that moving to a system that quotes stock prices in dollars and cents would create efficiency in the stock market that eighths and sometimes sixteenths can't permit’ (Torres and Salwen, 1991). This paper demonstrates the inefficiencies that result from constraining stocks to trade in eighths of a dollar. It describes the effects on returns and betas; then, it presents empirical evidence consistent with the effects. Systematic differences in the distributions of returns of low and high‐priced stocks are documented. The covariance of returns with a market index is shown to vary systematically across stocks of different prices and to depend on the return interval used to estimate market model parameters. The variations are explainable by an observed lag between the returns of low‐priced stocks relative to those of high‐priced stocks. The lag is partially attributable to trading in eighths. A systematic relationship that varies with share price is observed between market model residual returns and unadjusted returns. This relationship is not eliminated by using longer return intervals alone. The extent of the relationship is reduced when longer return intervals are combined with the use of a market index composed of stocks that are priced similarly to those of the securities being tested. The implications of these results for capital market studies are discussed.

Original languageEnglish (US)
Pages (from-to)409-427
Number of pages19
JournalJournal of Business Finance & Accounting
Volume21
Issue number3
DOIs
StatePublished - Jan 1 1994
Externally publishedYes

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Security returns
Market model
Securities and Exchange Commission
Market index
Lag
Pricing
Share prices
Empirical evidence
Stock market
Capital markets
Inefficiency
Stock prices
Equity

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting (miscellaneous)
  • Finance

Cite this

THE EFFECT OF TRADING IN EIGHTHS ON SECURITY RETURN BEHAVIOR. / Ingram, Robert W.; Stone, Mary S.; Dugan, Michael Timothy.

In: Journal of Business Finance & Accounting, Vol. 21, No. 3, 01.01.1994, p. 409-427.

Research output: Contribution to journalArticle

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