Review of Quantitative Finance and Accounting, 21: 5–15, 2003
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Maturity Effect on Bid-Ask Spreads of OTC
DAVID K. DING AND KOK-HUI TAN
Division of Banking and Finance, Nanyang Business School, Nanyang Technological University,
Singapore 639798, Singapore Tel.: (65) 6790-6269, Fax: (65) 6791-3697
E-mail: email@example.com; firstname.lastname@example.org; email@example.com
Abstract. The paper ascertains the relation between bid-ask spreads and the contract maturity of OTC currency
options. Contrary to previous ﬁndings in the futures market, spreads of currency options are found to be negatively
related to the contract’s term-to-maturity. The negative relation persists even after controlling for the effects of price
risks, competition, and trading activity. The pronounced differences in the term-to-maturity results are attributable
to the market risk effect and differences in the market structure of options and futures markets.
Key words: maturity effect, bid-ask spread, OTC, currency options, term-to-maturity
JEL Classiﬁcation: G10, G13, G14, G15
There is little in the microstructure literature that focuses on the effect of contract maturity
in the options market. Where spreads are concerned, the maturity effect is not an issue in
the equity market where studies have shown that the BAS is driven by information, risk,
competition, and trading activity (Stoll, 1978; Ho and Stoll, 1981; Glosten and Milgrom,
1985; McInish and Wood, 1992). Speciﬁcally, Copeland and Galai (1983), and Hasbrouck
(1988) have shown that the existence of informed traders induces a positive BAS. It has
been documented that the level of price volatility is positively related to the BAS (e.g.,
McInish and Wood, 1992, and others). Benston and Hagerman (1974), on the other hand,
show an inverse relation between spreads and the level of competition among traders. This
relationship has also been found between spreads and trading activity (Tinic, 1972; Tinic
and West, 1972). In this paper, we examine the unique contribution of the term-to-maturity
to the size of bid-ask spreads (BAS) in the OTC currency options market.
Unlike in the spot market, contract maturity is an important concern in derivative (options
and futures) markets. Not only is maturity vital to the valuation of derivative contracts,
it is essential in the determination of the BAS of derivatives contracts as well.
futures market, it has been established that the nearest maturity contracts generally have
the lowest BAS as they are typically the most active and have the lowest basis risk (Ding
and Chong, 1997; Ding, 1999). The impact of contract maturity on the BAS of option