Inferring the Components of the Bid‐Ask Spread: Theory and Empirical Tests

Inferring the Components of the Bid‐Ask Spread: Theory and Empirical Tests ABSTRACT The relation between the square of the quoted bid‐ask spread and two serial covariances—the serial covariance of transaction returns and the serial covariance of quoted returns—is modeled as a function of the probability of a price reversal, π, and the magnitude of a price change, ∂, where ∂ is stated as a fraction of the quoted spread. Different models of the spread are contrasted in terms of the parameters, π and ∂. Using data on the transaction prices and price quotations for NASDAQ/NMS stocks, π and ∂ are estimated and the relative importance of the components of the quoted spread—adverse information costs, order processing costs, and inventory holding costs—is determined. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

Inferring the Components of the Bid‐Ask Spread: Theory and Empirical Tests

The Journal of Finance, Volume 44 (1) – Mar 1, 1989

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Publisher
Wiley
Copyright
1989 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1989.tb02407.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT The relation between the square of the quoted bid‐ask spread and two serial covariances—the serial covariance of transaction returns and the serial covariance of quoted returns—is modeled as a function of the probability of a price reversal, π, and the magnitude of a price change, ∂, where ∂ is stated as a fraction of the quoted spread. Different models of the spread are contrasted in terms of the parameters, π and ∂. Using data on the transaction prices and price quotations for NASDAQ/NMS stocks, π and ∂ are estimated and the relative importance of the components of the quoted spread—adverse information costs, order processing costs, and inventory holding costs—is determined.

Journal

The Journal of FinanceWiley

Published: Mar 1, 1989

References

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