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Inferring the Components of the Bid‐Ask Spread: Theory and Empirical Tests
Author(s) -
STOLL HANS R.
Publication year - 1989
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1989.tb02407.x
Subject(s) - bid–ask spread , econometrics , transaction cost , covariance , bid price , ask price , economics , order (exchange) , database transaction , price discovery , financial economics , statistics , mathematics , computer science , microeconomics , monetary economics , market liquidity , finance , database , futures contract
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.