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Estimation of trading costs: Trade indicator models revisited

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  • Theissen, Erik
  • Zehnder, Lars Simon

Abstract

It is a stylized fact that trade indicator models (e.g. Madhavan, Richardson, and Roomans (1997) and Huang and Stoll (1997)) underestimate the bid-ask spread. We argue that this negative bias is due to an endogeneity problem which is caused by a negative correlation between the arrival of public information and trade direction. In our sample (the component stocks of the DAX30 index) we find that the the average correlation between these variables is -0.193. We develop modified estimators and show that they yield essentially unbiased spread estimates.

Suggested Citation

  • Theissen, Erik & Zehnder, Lars Simon, 2014. "Estimation of trading costs: Trade indicator models revisited," CFR Working Papers 14-09, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:1409
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    More about this item

    Keywords

    trade indicator model; information asymmetry; spread estimation;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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