A Dynamic Analysis of Bid-Ask Spreads with Multiple Trade Sizes
AbstractThis paper studies how the trade size and the historical sequence of trades affect bid-ask spreads, investors’ trading strategies, and the market maker’s learning process in a multi-period economy. First, we show that there is a nonzero cut-off size below which informed traders never buy or sell, and that larger trade sizes have positive bid-ask spreads, while smaller sizes do not. Then, we prove that the cut-off size decreases stochastically . We also derive the functional relationship between bid-ask spreads and trade sizes and show that bid- ask spreads are monotonically increasing in trade sizes. Moreover, we prove that when additional trade sizes are introduced to the market, the market maker’s learning process can be impaired and the bid-ask spreads for the previously existing trade sizes can vanish under a mild condition. We prove that the smaller trade sizes that do not have a positive bid-ask spread result in zero price change, while for larger trade sizes the rate at which price change increases is a decreasing function of the trade size in all trading periods. Most of our results are broadly consistent with the empirical findings.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0509007.
Length: 54 pages
Date of creation: 05 Sep 2005
Date of revision:
Note: Type of Document - pdf; pages: 54
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Market microstructure; insider trading; Glosten-Milgrom Model; asymmetric information; bid-ask spreads;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-11-09 (All new papers)
- NEP-FIN-2005-11-09 (Finance)
- NEP-FMK-2005-11-09 (Financial Markets)
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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