Inferring the Components of the Bid-Ask Spread: Theory and Empirical Tests
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, pi, and the magnitude of a price change, delta, where delta is stated as a function of the quoted spread. Different models of the spread are contrasted in term of the parameters, pi and delta. Using data on transaction prices and price quotations for NASDAQ/NMS stocks, pi and delta 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. Copyright 1989 by American Finance Association.
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Volume (Year): 44 (1989)
Issue (Month): 1 (March)
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