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A SIMPLE MODEL OF BID‐ASK SPREAD AND SEARCH
Author(s) -
Yavaş Abdullah
Publication year - 1993
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1002/j.1873-5924.1993.tb00566.x
Subject(s) - ask price , bid price , reservation , economics , price dispersion , search cost , microeconomics , search theory , online search , bid–ask spread , simple (philosophy) , reservation price , market maker , econometrics , computer science , monetary economics , finance , market liquidity , geography , computer network , philosophy , context (archaeology) , archaeology , epistemology , stock market , information retrieval
This paper analyzes a simple search model of market making in which the agents can choose between searching for a trading partner or trading through the market‐maker. Explicit solutions for the equilibrium search intensities and the bid‐ask spread have been provided. Equilibrium search intensities and the bid‐ask spread reflect the strategic interaction between the agents and the market‐maker: an increase in the bid‐ask spread results in higher search intensities. The bid‐ask spread, on the other hand, reacts negatively to an increase in the search intensities (due to lower search costs, higher efficiency of search, or higher gains from a match). It is also shown that the introduction of a market‐maker increases the seller's reservation price and decreases the buyer's reservation price, hence narrowing the price dispersion.