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Security Bid/Ask Dynamics with Discreteness and Clustering: Simple Strategies for Modeling and Estimation

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Author Info
Joel Hasbrouck
Abstract

The short-term movements of a security price reflect the latent efficient price (conditional expectation of terminal value) and also components arising from the trading mechanism itself. Observed bid and ask quotes are but rough signals of these unobserved quantities. The bid and ask quotes in the $/DM market considered here, for example, are discrete, with a tick size that is not trivial relative to the spread. Furthermore, the distribution of these quotes is clustered, with a greater-than-expected incidence of five-tick multiples. This paper suggests a simple framework for handling discrete, clustered quotes. Despite the simplicity of the model, estimation by traditional (likelihood or moment) methods is difficult. As an alternative, the paper implements a Gibbs sampler approach that proves to be quick and effective. This strategy opens the door for the investigation of a broad class of structural microstructure models.

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Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 98-042.

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Date of creation: 05 Oct 1998
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Handle: RePEc:fth:nystfi:98-042

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Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Web page: http://w4.stern.nyu.edu/finance/
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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.:

  1. Harris, Lawrence, 1990. "Estimation of Stock Price Variances and Serial Covariances from Discrete Observations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(03), pages 291-306, September. [Downloadable!]
  2. Christie, William G & Harris, Jeffrey H & Schultz, Paul H, 1994. " Why Did NASDAQ Market Makers Stop Avoiding Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1841-60, December. [Downloadable!] (restricted)
  3. Bollerslev, Tim & Melvin, Michael, 1994. "Bid--ask spreads and volatility in the foreign exchange market : An empirical analysis," Journal of International Economics, Elsevier, vol. 36(3-4), pages 355-372, May. [Downloadable!] (restricted)
  4. Michael K Pitt & Neil Shephard, . "Filtering via simulation: auxiliary particle filters," Economics Papers 1997-W13, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
  5. Bessembinder, Hendrik, 1994. "Bid-ask spreads in the interbank foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 35(3), pages 317-348, June. [Downloadable!] (restricted)
  6. Bernhardt, Dan & Hughson, Eric, 1996. "Discrete Pricing and the Design of Dealership Markets," Journal of Economic Theory, Elsevier, vol. 71(1), pages 148-182, October. [Downloadable!] (restricted)
  7. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351. [Downloadable!] (restricted)
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  8. Cordella, Tito & Foucault, Thierry, 1999. "Minimum Price Variations, Time Priority, and Quote Dynamics," Journal of Financial Intermediation, Elsevier, vol. 8(3), pages 141-173, July. [Downloadable!] (restricted)
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  9. Christie, William G & Schultz, Paul H, 1994. " Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?," Journal of Finance, American Finance Association, vol. 49(5), pages 1813-40, December. [Downloadable!] (restricted)
  10. Lyons, Richard K., 1996. "Optimal Transparency in a Dealer Market with an Application to Foreign Exchange," Journal of Financial Intermediation, Elsevier, vol. 5(3), pages 225-254, July. [Downloadable!] (restricted)
  11. Hausman, Jerry A. & Lo, Andrew W. & MacKinlay, A. Craig, 1992. "An ordered probit analysis of transaction stock prices," Journal of Financial Economics, Elsevier, vol. 31(3), pages 319-379, June. [Downloadable!] (restricted)
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  12. Dutta, Prajit K & Madhavan, Ananth, 1997. " Competition and Collusion in Dealer Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 245-76, March. [Downloadable!] (restricted)
  13. Jong-Il Kim & Lawrence J. Lau, 1996. "The sources of Asian Pacific economic growth," Canadian Journal of Economics, Canadian Economics Association, vol. 29(s1), pages 448-54, April. [Downloadable!] (restricted)
  14. Chib, Siddhartha & Greenberg, Edward, 1996. "Markov Chain Monte Carlo Simulation Methods in Econometrics," Econometric Theory, Cambridge University Press, vol. 12(03), pages 409-431, August. [Downloadable!]
  15. Anshuman, V Ravi & Kalay, Avner, 1998. "Market Making with Discrete Prices," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(1), pages 81-109.
  16. Kandel, Eugene & Marx, Leslie M., 1997. "Nasdaq market structure and spread patterns," Journal of Financial Economics, Elsevier, vol. 45(1), pages 61-89, July. [Downloadable!] (restricted)
  17. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September. [Downloadable!] (restricted)
  18. repec:cup:etheor:v:12:y:1996:i:3:p:409-31 is not listed on IDEAS
  19. Kim, Sangjoon & Shephard, Neil & Chib, Siddhartha, 1998. "Stochastic Volatility: Likelihood Inference and Comparison with ARCH Models," Review of Economic Studies, Blackwell Publishing, vol. 65(3), pages 361-93, July. [Downloadable!] (restricted)
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  20. Chan, K C & Christie, William G & Schultz, Paul H, 1995. "Market Structure and the Intraday Pattern of Bid-Ask Spreads for NASDAQ Securities," Journal of Business, University of Chicago Press, vol. 68(1), pages 35-60, January. [Downloadable!] (restricted)
  21. Schwert, G. William, 1997. "Symposium on market microstructure: Focus on Nasdaq," Journal of Financial Economics, Elsevier, vol. 45(1), pages 3-8, July. [Downloadable!] (restricted)
  22. Troesken, Werner, 1997. "The," Journal of Law, Economics and Organization, Oxford University Press, vol. 13(1), pages 1-25, April.
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  24. Gottlieb, Gary & Kalay, Avner, 1985. " Implications of the Discreteness of Observed Stock Prices," Journal of Finance, American Finance Association, vol. 40(1), pages 135-53, March. [Downloadable!] (restricted)
  25. Jacquier, Eric & Polson, Nicholas G & Rossi, Peter E, 1994. "Bayesian Analysis of Stochastic Volatility Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(4), pages 371-89, October.
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  1. Jeremy Large, 2005. "Estimating quadratic variation when quoted prices jump by a constant increment," Economics Papers 2005-W05, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
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