Spread decomposition with common spread components
AbstractPurpose – This paper aims to incorporate a market wide buying and selling pressure cost component into a spread decomposition model as spread cost component. Design/methodology/approach – The paper extends a commonly used trade indicator spread decomposition model to include a component common to all stocks of a specialist firm and a market wide component common to all stocks. Findings – Strong evidence is found that specialists consider this common factor cost component when they set bid and ask quotes. Some specialist firms also take the next logical step and specifically manage their firm wide stock inventories. The common factor is in percentage terms largest for securities with the highest trade frequencies. Research limitations/implications – The relative importance of the common factor spread component decreases as the pricing grid becomes finer, but remains highly significant under the decimal trading regime. Originality/value – This is the first study to document not-security-specific spread cost components that are common to all stocks for which a specialist firm makes markets and to all stocks in the market. Using the model it is shown that market wide uncertainty translates into spreads of individual securities.
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Bibliographic InfoArticle provided by Emerald Group Publishing in its journal International Journal of Managerial Finance.
Volume (Year): 6 (2010)
Issue (Month): 2 (April)
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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