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THE DETERMINANTS AND DYNAMICS OF BID‐ASK SPREADS ON THE LONDON STOCK EXCHANGE
Author(s) -
Menyah Kojo,
Paudyal Krishna
Publication year - 1996
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.1996.tb00220.x
Subject(s) - monetary economics , competition (biology) , economics , stock (firearms) , stock exchange , private information retrieval , financial economics , order (exchange) , econometrics , business , finance , statistics , mechanical engineering , ecology , mathematics , engineering , biology
We analyze the effect of various factors on the size of spreads on the London Stock Exchange since “Big Bang” and find that the price of a security, volume of transactions, risk associated with security returns, and degree of competition among market makers explain 91 percent of the cross‐sectional variation in spreads. The results are consistent with the argument that the inside spread encompasses the order‐processing, inventory‐adjustment, and adverse‐information cost of spreads. We also investigate the speed at which spreads move toward their normal levels after a temporary deviation. Although the speed of adjustment varies across firms, the cross‐sectional median of 0.896 indicates it takes more than one period (day) for the adjustment to be completed. The volume of transactions and the degree of competition among market makers are the significant factors that affect the speed of correction in spreads toward their normal levels. This implies private information is incorporated more quickly into prices for stocks with greater competition and high trading volume.