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Bias in the effective bid-ask spread

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  • Hagströmer, Björn

Abstract

The effective bid-ask spread measured relative to the spread midpoint overstates the true effective bid-ask spread in markets with discrete prices and elastic liquidity demand. The average bias is 13%–18% for S&P 500 stocks in general, depending on the estimator used as benchmark, and up to 97% for low-priced stocks. Cross-sectional bias variation across stocks, trading venues, and investor groups can influence research inference. The use of the midpoint also undermines liquidity timing and trading performance evaluations, and can lead non-sophisticated investors to overpay for liquidity. To overcome these problems, the paper proposes new estimators of the effective bid-ask spread.

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  • Hagströmer, Björn, 2021. "Bias in the effective bid-ask spread," Journal of Financial Economics, Elsevier, vol. 142(1), pages 314-337.
    • Handle: RePEc:eee:jfinec:v:142:y:2021:i:1:p:314-337
    DOI: 10.1016/j.jfineco.2021.04.018
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    Cited by:

    1. Jean-Laurent Cadorel, 2024. "The 1929 Crash of the New York Stock Exchange as a Liquidity Crisis [Le Krach de 1929 du New York Stock Exchange comme crise de liquidité]," Post-Print hal-04347097, HAL.

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    More about this item

    Keywords

    Midpoint; Micro-price; Liquidity demand elasticity; Illiquidity; Rule 605;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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