Price clustering and the stability of stock prices

Understanding factors that influence volatility is vital to analysts, investment professionals, and firm managers. In this study, we take a non-traditional approach to identify the determinants of volatility by examining how frictions in the formation of prices affect the stability of stock prices. In particular, we test the hypothesis that clustering on round pricing increments will result in more volatile financial markets. A possible explanation for clustering-induced volatility may be that stocks with a greater degree of clustering will have less informative prices and thus exhibit greater volatility. Our multivariate tests seem to confirm our hypothesis as we observe a strong, positive relation between price clustering and stock price volatility. A variety of additional tests suggest that causation flows from clustering to volatility instead of the other way around.