Market making with discrete prices

Exchange-mandated discrete pricing restrictions create a wedgebetween the underlying equilibrium price and the observed price.This wedge permits a competitive market maker to realize economicprofits that could help recoup fixed costs. The optimal ticksize that maximizes the expected profits of the market makercan equal to $1/8 for reasonable parameter values. The optimaltick size is decreasing in the degree of adverse selection.Discreteness per se can cause time-varying bid-ask spreads,asymmetric commissions, and market breakdowns. Discreteness,which imposes additional transaction costs, reduces the valueof private information. Liquidity traders can benefit undercertain conditions.