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Risk Aversion and the Bid–Ask Spread
Author(s) -
Roger P.,
Eeckhoudt L.
Publication year - 1999
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/1468-036x.00098
Subject(s) - bid price , ask price , monopolistic competition , bid–ask spread , economics , asset (computer security) , market maker , econometrics , risk aversion (psychology) , microeconomics , expected utility hypothesis , financial economics , market liquidity , monetary economics , finance , computer science , paleontology , computer security , horse , stock market , biology , monopoly
This paper studies the properties of bid and ask prices posted by a monopolistic market maker, without parametric assumptions about the utility function of the market maker or about the probability distribution of the return of the risky asset. We first prove that the two prices can be higher or lower than the expected value of the asset, and that the spread is decreasing in the initial wealth when the market maker exhibits decreasing absolute risk aversion. We conclude by some examples illustrating the fact that almost all shapes can be obtained for the bid–ask spread (as a function of the inventory) depending on the probability distribution of the payment of the risky asset.