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BID‐ASK SPREAD COMPONENTS IN AN ORDER‐DRIVEN ENVIRONMENT
Author(s) -
Brockman Paul,
Chung Dennis Y.
Publication year - 1999
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.1475-6803.1999.tb00724.x
Subject(s) - bid–ask spread , decile , adverse selection , order processing , ask price , order (exchange) , liberian dollar , bid price , econometrics , economics , business , market maker , financial economics , stock exchange , stock market , marketing , actuarial science , statistics , geography , mathematics , finance , supply chain , context (archaeology) , archaeology
The purpose of this study is to extend the bid‐ask spread decomposition literature into the order‐driven environment. The use of electronic limit order books, combined with order‐driven market making, has been increasing rapidly in recent years because of improvements in information technology and financial market deregulation. To date, reported bid‐ask spread decompositions rely almost exclusively on quote‐driven or hybrid systems. This study provides bid‐ask spread component estimates from one of the world's largest order‐driven markets, the Stock Exchange of Hong Kong. Based on a sample of over six million observations, we estimate a median adverse selection component of 33 percent and a median order processing component of 45 percent of the spread. Dollar‐volume‐based decile portfolios show significant cross‐sectional variation for adverse selection costs but insignificant variation for order processing costs. Finally, order persistence is consistently positive for all deciles and displays a direct relation with the level of trading activity.