The Components of the Bid-Ask Spread: A General Approach

The Components of the Bid-Ask Spread: A General Approach A simple time-series market microstructure model is constructed within which existing models of spread components are reconciled. We show that existing models fail to decompose the spread into all its components. Two alternative extensions of the simple model are developed to identify all the components of the spread and to estimate the spread at which trades occur. The empirical results support the presence of a large order processing component and smaller, albeit significant, adverse selection and inventory components. The spread components differ significantly according to trade size and are also sensitive to assumptions about the relation between orders and trades. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

The Components of the Bid-Ask Spread: A General Approach

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Publisher
Oxford University Press
Copyright
Oxford University Press
ISSN
0893-9454
eISSN
1465-7368
D.O.I.
10.1093/rfs/10.4.995
Publisher site
See Article on Publisher Site

Abstract

A simple time-series market microstructure model is constructed within which existing models of spread components are reconciled. We show that existing models fail to decompose the spread into all its components. Two alternative extensions of the simple model are developed to identify all the components of the spread and to estimate the spread at which trades occur. The empirical results support the presence of a large order processing component and smaller, albeit significant, adverse selection and inventory components. The spread components differ significantly according to trade size and are also sensitive to assumptions about the relation between orders and trades.

Journal

The Review of Financial StudiesOxford University Press

Published: Oct 4, 1997

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