Minimum Trade Unit and Liquidity: The Case of the Korea Exchange

In this paper, we investigate the effect of reductions in the minimum trade unit (MTU) on liquidity. The Korea Exchange reduced its MTU from 10 shares to one share for high-price stocks twice, once in 2004 and once in 2006. We use these rare events to examine whether the MTU reductions increased or decreased liquidity and whether the events increased or decreased informed trading. We find that, after the MTU reductions, the bid-ask spread and the trade size decreased along with an increase in small investor participation. However, there are no signs of an increase in trading volume. We also find partial evidence of an increase in informed trading. However, the increase in informed trading is matched by a far greater increase in liquidity trading. As a result, the probability that uninformed traders face informed traders in their trading did not increase. The overall evidence indicates that, with greater price competition, small investors benefit from a smaller trade unit along with improved liquidity for small trades.