Options and earnings announcements: an empirical study of volatility, trading volume, open interest and liquidity

In this paper we study the impact of earnings announcements on implied volatility, trading volume, open interest and spreads in the stock options market. We find that implied volatility increases before announcement days and drops afterwards. Also option trading volume is higher around announcement days. During the days before the announcement open interest tends to increase, while it returns to regular levels afterwards. Changes in the quoted spread largely respond to higher trading volume and changes in implied volatility. The effective spread increases on the event day and on the first two days following the earnings announcement.     

FX spreads and dealer competition across the 24-hour trading day

This study examines the impact of competition on bid-ask spreadsin the spot foreign exchange market. We measure competitionprimarily by the number of dealers active in the market andfind that bid-ask spreads decrease with an increase in competition,even after controlling for the effects of volatility. The expectedlevel of competition is time varying, highly predictable, anddisplays a strong seasonal component that in part is inducedby geographic concentration of business activity over the 24-hourtrading day. Our estimates show that the expected addition ofone more competing dealer lowers the average quoted spread by1.7%     

Intraday futures market behaviour around major scheduled macroeconomic announcements: Australian evidence

This paper examines intraday futures market behaviour around major scheduled macroeconomic information announcements on the Sydney Futures Exchange (SFE). Prior literature analysing intraday price behaviour around announcements is extended to trading volume and quoted bid–ask spreads. The analysis of price volatility, trading volume and quoted bid–ask spreads indicates that the majority of adjustment to new information occurs rapidly, within 240 seconds of the scheduled time for major announcements, with some evidence of abnormal activity prior to announcements. Analysis of quoted bid–ask spreads suggests that they significantly widen in the 20 seconds prior to announcements and remain significantly wider for 30 seconds following announcements. The increase in quoted spreads is related to both expected and unexpected volatility, implying that market participants increase quoted spreads around information announcements as a consequence of adverse selection costs.     

European asset swap spreads and the credit crisis

We examine time-varying behaviour and determinants of asset swap (ASW) spreads for 23 iBoxx European corporate bond indexes from January 2006 to January 2009. The results of a Markov switching model suggest that ASW spreads exhibit regime-dependent behaviour. The evidence is particularly strong for Financial and Corporates Subordinated indexes. Stock market volatility determines ASW spread changes in turbulent periods, whereas stock returns tend to affect spread changes in calm periods. While market liquidity affects spreads only in turbulent regimes the level of interest rates is an important determinant of spread changes in both regimes. Finally, we identify stock returns, lagged ASW spread levels, and lagged volatility of ASW spreads as major drivers of the regime shifts. The results are robust in the extended sample (January 2006 to October 2013) that includes a post-crisis period.     

Competition on the Nasdaq and the growth of electronic communication networks

This paper examines the growth of electronic communication networks (ECNs) and their competitive impact on the Nasdaq. We find that the development of these alternative trading platforms is associated with tighter quoted, effective, and relative bid–ask spreads, greater depths, and less concentrated markets. Further, our results show that an increase in ECN trading may have caused some traditional market makers (wholesaler and national retail dealers) to exit the market for market making. Overall, our results suggest that ECNs provide a source of competition to traditional Nasdaq dealers.     

Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing

In this paper we provide empirical evidence consistent with the hypothesis that options market makers face risks in managing inventory that are unique to the options markets. In particular, we show that risks associated with the inability to rebalance an option position continuously and uncertainty about the return volatility of the underlying stock each account for a statistically and economically significant proportion of the bid-ask spreads quoted for a sample of Chicago Board Options Exchange options.     

A study on foreign exchange dealers' bid–ask spread quote behavior

Based on a questionnaire surveying dealers in the Taipei inter-bank foreign exchange market that was conducted in March 2001, I attempted to answer the question of who initiated the wider currency spread. It was found that the risk-averse dealers of small banks quoted wider spreads in order to conceal their inferior positions regarding information and inventory or to avoid market volatility risk. Some of the dealers of large multinational banks in major financial centers who normally quote conventional spreads were found to quote wider spreads in response to the request for quotations by small Taiwanese bank dealers who widened their spread quotes.     

Market structure and microstructure, in international interest rate futures markets

We examine the role of market structure in identifying microstructure features of the NYSE.Euronext-LIFFE STIR futures market by comparing the ability of two bid-ask spread component models to explain bid-ask spreads. These two models differ only in their assumptions about whether or not market makers are present. The period we analyze includes data from pit-based trading alongside electronic market data. We explore how market structure affects the way private information influences bid-ask spreads and return volatility. A second part of our study employs intraday correlation to investigate these links in greater depth, while a third part looks at how private information and trading noise contribute to price evolution.     

The Impact of Market Maker Competition on Nasdaq Spreads

This study utilizes a comprehensive database containing monthly information on the number of market makers for about 5,288 Nasdaq securities over an eight-year period to investigate the impact of competition on spreads. A variety of models are estimated in order to demonstrate the robustness of the results that include four specific findings: (1) the number of market makers has a negative and highly significant impact on spreads; (2) the relation is nonlinear with a decreasing impact by the marginal market maker; (3) Nasdaq spreads have been declining over time; and (4) structural changes in Nasdaq are associated with significant changes in the relationship between spread and the number of market makers. One improvement over the literature includes allowing endogenous competition through the use of instrumental variables.     

Information Asymmetry and the Bid‐Ask Spread: Evidence From the UK

Abstract:   The generally accepted factors that determine the bid‐ask spread are volatility, trading volume and market value ( Atkins and Dyl, 1997 ; Glosten and Harris, 1988 ; and Menyah and Paudyal, 2000 ). Following Kim and Verrecchia (1994) we include a measure of the disagreement in analysts' earnings forecasts in our model of the bid ask spread. This measure serves as a proxy for the informational disadvantage of market makers with respect to informed traders. Market makers respond to the additional risk by increasing the bid‐ask spread. We find that the disagreement amongst analysts is significant for horizons up to and including six months (and with the hypothesised sign) in explaining FTSE 100 company spreads, rendering strong empirical support for our model.     

Insider Trading and the Bid-Ask Spread

This study examines the intertemporal and cross-sectional association between the bid-ask spread and insider trading. Empirical results from the cross-sectional regression analysis reveal that market makers establish larger spreads for stocks with a greater extent of insider trading. The time-series regression analysis, however, finds no evidence of spread changes on insider trading days. These results suggest that although market makers may not be able to detect insider trading when it occurs, they protect themselves by maintaining larger spreads for stocks with a greater tendency of insider trading. The results also reveal that market makers establish larger spreads when there are unusually large transactions. In addition, this study finds that spreads are positively associated with risk and negatively with trading volume, the number of exchange listings, share price, and firm size.     

Effects of the volatility smile on exchange settlement practices: The Hong Kong case

The well-documented volatility smile phenomenon in the US options market has affected the option settlement practices of other markets. To settle Hang Seng Index (HSI) options, the Hong Kong Stock Exchange artificially builds in a piecewise linear “smile” or “sneer” volatility function, which is determined daily by market makers rather than directly by market forces. In this study, we investigate the time-varying settlement function and find the following economic determinants of the volatility function: lag parameters, current-day HSI returns, the distribution of HSI returns, transaction costs as proxied by the bid-ask spread, and the “Monday effect”. For evaluation purposes, we use as a benchmark the estimated piecewise linear volatility function as directly driven by market forces. The comparison analyses show that base volatilities set by market makers run somewhat high, while downside slopes are not steep enough. This results in the overpricing of the lion’s share of traded options. An economic determinants analysis of market-force-driven parameters reveals that market makers can better align artificial volatility parameters both by reducing reliance on the function parameters of prior days and by more precisely accounting for current-day HSI returns, option time-to-maturity, bid-ask spreads and buying pressure.     

Modeling volatility and changes in the swap spread

We investigate the determinants of changes in U.S. interest rate swap spreads using a model that explicitly allows for volatility interactions between swaps of different terms to maturity. Changes in the swap spread are found to be positively related to interest rate volatility, to changes in the default risk premium in the corporate bond market, and to changes in the liquidity premium for government securities. Swap spread changes are negatively related to changes in the level of interest rates and changes in the slope of the term structure. We also find that there is a strong and significant volatility interaction among spreads for swaps of different maturities and that the process for the conditional variance of the spread is highly persistent across all maturities.     

Market microstructure of the Pink Sheets

We study the microstructure of the Pink Sheets and assess the ability of existing theory to capture salient features of this relatively unstructured and unregulated market. Clustering patterns in quotes, quoted spreads, and trade prices indicate that market participants have selected price-dependent tick sizes for different stocks. Clustering intensity varies across stocks as a function of proxies for information availability. Similarly, the bid-ask spread varies as a function of volatility and liquidity. These results suggest (1) microstructure research has established robust predictions of market attributes and (2) unstructured markets are able to develop at least some effective behavioral norms endogenously.     

Local market makers, liquidity and market quality

We examine the role of geographically proximate (local) market makers in providing liquidity and improving the quality of a dealer market. Firms with active participation of local dealers enjoy lower quoted and effective spreads, as well as more informative prices. The beneficial effects from local market makers are not confined to a few “top” local dealers and they cannot be attributed to their participation in the firm's IPO syndicate or industry specialization. Further, we find that days with aggressive bidding from local market makers relative to their non-local counterparts are associated with significant positive abnormal returns, consistent with local market makers possessing information advantages. In summary, our results suggest that the information advantages of local market makers may be a contributing factor to the reduction in the cost of trading.     

An empirical examination of the impact of market microstructure changes on the determinants of option bid-ask spreads

This paper examines the determinants of bid-ask spreads in the Australian Options Market before and after it switched from a quote-driven floor-traded market to an order-driven screen-traded market. This study reports that both put and call option bid-ask spreads are positively related to the option's value, its remaining term-to-maturity, its absolute hedge ratio and the volatility of returns from the underlying asset and negatively related to the level of trading activity in that option series. The study also reports that spreads are generally less when market makers are obliged to maintain continuous quotes in the market. The paper also finds that following the change in trading regime, both call and put option spreads became more sensitive to the absolute value of the option's delta. This finding is consistent with previous theoretical and empirical work from equities markets that has suggested that a switch to an electronic trading regime results in an increase in the adverse selection component of the bid-ask spread. There is also some limited evidence that suggests that the switch to electronic trading resulted in call option spreads being less sensitive to the return volatility of the underlying asset but more sensitive to the option's price.     

The Quality of ECN and Nasdaq Market Maker Quotes

This paper compares the quality of quotes submitted by electronic communication networks (ECNs) and by traditional market makers to the Nasdaq quote montage. An analysis of the most active Nasdaq stocks shows that ECNs not only post informative quotes, but also, compared to market makers, ECNs post quotes rapidly and are more often at the inside. Additionally, ECN quoted spreads are smaller than dealer quoted spreads. The evidence suggests that the proliferation of alternative trading venues, such as ECNs, may promote quote quality rather than fragmenting markets. Moreover, the results suggest that a more open book contributes to quote quality.     

An empirical comparison of quoted and implied bid–ask spreads on futures contracts

This paper investigates the performance of a range of alternative measures of quoted and implied bid–ask spreads on futures contracts, using a complete record of all quotes and trades. Accurate calibration of bid–ask spreads is important for many applications, including tests of market efficiency and assessment of market microstructure models. The results show that the transactions based spread measures are biased estimates of quoted and effective spreads, which illustrates the need for considered implementation of such measures. Similar intraday behaviour is shown by the different measures, with wide spreads at the open and narrow spreads at the close under a competing market maker environment.     

Tick Size,Spreads, and Liquidity: An Analysis of Nasdaq Securities Trading near Ten Dollars

Quoted and effective bid–ask spreads on Nasdaq are two to four cents per share narrower, ceteris paribus, when stocks trade with a smaller tick size below $10 per share. There is no evidence of a reduction in liquidity with the smaller tick size. The largest spread reductions occur for stocks whose market makers avoid odd-eighth quotes. This finding provides support for models implying that changes in the tick size can affect equilibrium spreads on a dealer market and indicates that the relation between tick size and market quality is more complex than the imposition of a constraint on minimum spread widths. Journal of Economic Literature Classification Numbers: G29, D34, N20.     

Trading Patterns and Prices in the Interbank Foreign Exchange Market

The behavior of quote arrivals and bid-ask spreads is examined for continuously recorded deutsche mark-dollar exchange rate data over time, across locations, and by market participants. A pattern in the intraday spread and intensity of market activity over time is uncovered and related to theories of trading patterns. Models for the conditional mean and variance of returns and bid-ask spreads indicate volatility clustering at high frequencies. The proposition that trading intensity has an independent effect on returns volatility is rejected, but holds for spread volatility. Conditional returns volatility is increasing in the size of the spread.