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Bid-Ask Spread Components in an Order-Driven Environment

  • Brockman, Paul
  • Chung, Dennis Y
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    The purpose of this study is to extend the bid-ask spread decomposition literature into the order-driven environment. The use of electronic limit order books combined with order-driven market making has been increasing rapidly in recent years because improvements in information technology and financial market deregulation. To date, reported bid-ask spread decompositions rely almost exclusively on quote-driven or hybrid systems. This study provides bid-ask spread component estimates from one of the world's largest order-driven markets, the Stock Exchange of Hong Kong. Based on a sample of over six million observations, we estimate a median adverse selection component of 33 percent and a median order processing component of 45 percent of the spread. Dollar volume-based decile portfolios show significant cross-sectional variation for adverse selection costs but insignificant variation for order processing costs. Finally, order persistence is consistently positive for all deciles and displays a direct relation with the level of trading activity.

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    Article provided by Southern Finance Association & Southwestern Finance Association in its journal Journal of Financial Research.

    Volume (Year): 22 (1999)
    Issue (Month): 2 (Summer)
    Pages: 227-46

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    Handle: RePEc:bla:jfnres:v:22:y:1999:i:2:p:227-46
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