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Information Effects on the Bid‐Ask Spread

Information Effects on the Bid‐Ask Spread ABSTRACT An individual who chooses to serve as a market‐maker is assumed to optimize his position by setting a bid‐ask spread which maximizes the difference between expected revenues received from liquidity‐motivated traders and expected losses to information‐motivated traders. By characterizing the cost of supplying quotes, as writing a put and a call option to an information‐motivated trader, it is shown that the bid‐ask spread is a positive function of the price level and return variance, a negative function of measures of market activity, depth, and continuity, and negatively correlated with the degree of competition. Thus, the theory of information effects on the bid‐ask spread proposed in this paper is consistent with the empirical literature. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

Information Effects on the Bid‐Ask Spread

The Journal of Finance , Volume 38 (5) – Dec 1, 1983

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References (28)

Publisher
Wiley
Copyright
1983 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
DOI
10.1111/j.1540-6261.1983.tb03834.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT An individual who chooses to serve as a market‐maker is assumed to optimize his position by setting a bid‐ask spread which maximizes the difference between expected revenues received from liquidity‐motivated traders and expected losses to information‐motivated traders. By characterizing the cost of supplying quotes, as writing a put and a call option to an information‐motivated trader, it is shown that the bid‐ask spread is a positive function of the price level and return variance, a negative function of measures of market activity, depth, and continuity, and negatively correlated with the degree of competition. Thus, the theory of information effects on the bid‐ask spread proposed in this paper is consistent with the empirical literature.

Journal

The Journal of FinanceWiley

Published: Dec 1, 1983

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