JOURNAL OF FINANCIAL INTERMEDIATION 5, 2–22 (1996) ARTICLE NO. 0002 Tick Size, Spread, and Volume HEE-JOON AHN,CHARLES Q. CAO, AND HYUK CHOE* Department of Finance, The Pennsylvania State University, University Park, Pennsylvania 16802 Received January 17, 1995; accepted October 31, 1995 The AMEX changed the tick size from $  to $  for low-price stocks on September 3, 1992. Consistent with the prediction of L. E. Harris (1994, Minimum price varia- tions, discrete bid–ask spreads, and quotation sizes, Rev. Finan. Stud. 7, 149–178), the change has reduced both quoted and effective spreads, although the magnitude of the reduction is much smaller than predicted. However, we fail to find evidence of a significant increase in trading volume. Our cross-sectional regressions show that stocks with greater trading activity, lower prices, and stronger competition from the regional exchanges experienced greater spread reductions. Journal of Economic Literature Classification Numbers: G10, G18, G20.  1996 Academic Press, Inc. 1. INTRODUCTION The American Stock Exchange (AMEX) reduced the minimum price variation (tick size) from $ to $  for stocks priced between $1 and $5 on September 3, 1992. We exploit this rare opportunity to investigate the effect of the reduction in the minimum price variation on bid–ask spread, trading volume, and market depth. Our investigation is important for two reasons. One, it is the first out-of-sample test of the Harris (1994) model. The Harris model provides a specific prediction regarding the impact of the reduction in the minimum price variation on bid–ask spread, trading volume, and market depth. Two, perhaps more importantly, it provides direct evidence useful in understanding the costs and benefits of changing the century-old $ fractional pricing system in the stock market. How exchange specialists and investors will respond to changes in the minimum spread size and to * We are grateful to Jim Angel, Robert Battalio, Larry Glosten, Frederick Harris, Frank Hatheway, Roger Huang, and the JFI editors and referees for their helpful comments. Address correspondence to Hyuk Choe, 609 BAB I, Department of Finance, The Pennsylvania State University, University Park, PA 16802. 2 1042-9573/96 $18.00 Copyright  1996 by Academic Press, Inc. All rights of reproduction in any form reserved.