Inferring the Components of the Bid‐Ask Spread: Theory and Empirical Tests
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- Author(s): HANS R. STOLL
- Published: Apr 30, 2012
- Pages: 115-134
- DOI: 10.1111/j.1540-6261.1989.tb02407.x
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, π, and the magnitude of a price change, ∂, where ∂ is stated as a fraction of the quoted spread. Different models of the spread are contrasted in terms of the parameters, π and ∂. Using data on the transaction prices and price quotations for NASDAQ/NMS stocks, π and ∂ 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.