DIVIDEND POLICY AND THE BID-ASK SPREAD: AN EMPIRICAL ANALYSIS

Extant theories of the bid-ask spread posit a positive relationship between the level of information asymmetry and the magnitude of the spread. As suggested by dividend signaling and agency theories, the payment of dividends conveys information to the market, thereby reducing asymmetry. Thus, dividend policy may influence the bid-ask spread. Based on this reasoning, we explore the empirical proposition that an inverse relation between dividend yield and bid-ask spread exists, ceteris paribus. Evidence is consistent with this hypothesis.     

The Changing Asymmetric Information Component of REIT Spreads: A Study of Anticipated Announcements

This study examines the risk-compensating behavior of REIT market makers. The bid-ask spread is hypothesized to compensate market makers for three costs: asymmetric information, order processing, and inventory. As the market makers perceived likelihood of transacting with a better-informed individual increases (decreases), the percentage of the spread that is attributed to asymmetric information will increase (decrease). This study examines the asymmetric information component of the bid-ask spread immediately prior to and following REIT dividend announcements and REIT funds from operations announcements during 1995 and 1996. The asymmetric information component increases the day before and then declines subsequent to dividend announcements of small and equity REITs. Asymmetric information costs increase following funds from operations announcements.     

Information Asymmetry and the Dealer's Bid-Ask Spread: A Case Study of Earnings and Dividend Announcements

Recent theoretical work on the bid-ask spread asserts that the dealer should widen the bid-ask spread when he or she suspects that the information advantage possessed by informed traders has increased. Thus, the dealer's spread can be employed to test for an increase in information asymmetry prior to an anticipated information event. In this paper, the method is applied to earnings and dividend announcements, which have been documented to be information events. The authors study three groups of announcements: (a) joint announcements—i.e., earnings and dividend announcements that are made on the same day, (b) initial (first) announcements—earnings or dividend announcements that were not preceded by another announcement in the prior thirty days, and (c) following (second) announcements—those announcements that follow the first announcement by at least ten days but by no more than thirty days. The authors find a strong increase in information asymmetry only before the second announcements and virtually no increase before the joint and first announcements. This is consistent with the hypothesis that there is, on average, normal information asymmetry before announcements, but that the dealer will suspect a nonroutine announcement (with an attendant increase in information asymmetry) when the second announcement is separated from the first by more than ten days. Other possible explanations for the results are discussed, and suggestions for future research are outlined.     

BID-ASK SPREAD COMPONENTS AROUND ANTICIPATED ANNOUNCEMENTS

In this paper I re-examine spreads around dividend and earnings announcements and provide new evidence on patterns by examining the components of the bid-ask spread. Transaction data are examined through a recently developed spread decomposition model that decomposes the bid-ask spread into a fixed (execution) component and an adverse selection component. In addition, this model does not rely on a constant spread as previous spread decomposition models require. The results show that around earnings announcements, the bid-ask spreads and spread components have significant changes indicating that the anticipated announcement is informative. However, the actual public announcement of a dividend does not alter the bid-ask spread and spread components of actively traded securities.     

WINNERS AND LOSERS ON NYSE: A RE-EXAMINATION USING DAILY CLOSING BID-ASK SPREADS

We study a sample of NYSE stocks that experienced a large one-day price change during 1992 and were reported as daily largest percentage gainers and largest percentage losers in the Wall Street Journal. The sample indicates significant reversals during the immediate post-announcement period. We test for market efficiency by using bid-ask spreads obtained from the transactions data for the days immediately after the announcement. The overall results indicate that the returns during the reversal period are less than the average bid-ask spread during the same time. We also find that major losers, firms with ?20 percent to ?50 percent event-date abnormal returns, experience price reversals generating returns that are significantly greater than the average bid-ask spread during that period. We interpret this result as consistent with the overreaction hypothesis. A test of a trading rule to exploit this overreaction is not profitable, providing support for weak-form market efficiency.     

Determinants of yield spread dynamics: Euro versus US dollar corporate bonds

This paper presents a systematic comparison between the determinants of euro and US dollar yield spread dynamics. The results show that US dollar yield spreads are significantly more affected by changes in the level and the slope of the default-free term structure and the stock market return and volatility. Surprisingly, euro yield spreads are strongly affected by the US (and not the euro) level and slope. This confirms the dominance of US interest rates in the corporate bond markets. Interestingly, I find that liquidity risk is higher for US dollar corporate bonds than euro corporate bonds. For both regions, the effect of changes in the bid-ask spread is mainly significant during periods of high liquidity risk. Finally, the results indicate that the credit cycle as measured by the region-specific default probability significantly increases US yield spreads. This is not the case for euro yield spreads.     

Ex-Day Behavior: Tax or Short-Term Trading Effects

This study examines the behavior of share prices around the ex-dividend dates before and after the introduction of the 1988 Income and Corporation Taxes Act that reduced substantially the tax differential between dividends and capital gains in the United Kingdom. We find that, in the pre-1988 period when the differential taxation of dividends and capital gains is high, ex-day returns are positive and significant. In contrast, in the post-1988 period, ex-day returns are, in most cases, negative and insignificant. Further analysis reveals that, while ex-day returns are significantly related to dividend yield and to the length of the settlement period, they are not affected by the commonly used measures of transaction costs, such as the bid-ask spread and trading volume, or by the day of week, month of the year, type of dividend distribution, or number of days to the actual receipt of the cash dividend. We conclude that taxation affects significantly ex-day share prices in the United Kingdom.     

Trading Behavior and the Unbiasedness of the Market Reaction to Dividend Announcements

This article examines the price formation process during dividend announcement day, using daily closing prices and transactions data. We find that the unconditional positive excess returns, first documented by Kalay and Loewenstein (1985) , are higher for small-firm and low-priced stocks. Price volatility and trading volume also increase during this period. Examination of trade prices relative to the bid-ask spread and volume of trades at bid and asked prices shows that the excess returns cannot be attributed to measurement errors or to spillover effects of tax-related ex-day trading. Rather, the price behavior is related to the absorption of dividend information.     

The Impact of the Reduction in Tick Increments in Major U.S. Markets on Spreads,Depth, and Volatility

This study presents an analysis of the impact of the introduction of quotes in sixteenths of a dollar on the AMEX, Nasdaq, and NYSE in mid-1997 on select market characteristics such as spreads, effective spreads, quoted depth, and volume. The findings of the study document reductions in the bid-ask spread, effective spread, and a statistically significant increase in the number of quotes. Interestingly, we find that liquidity, as measured by the total depth at the bid and ask, declines significantly on the AMEX and NYSE, but increases on the Nasdaq. Trading volume increases on the NYSE, but remains unchanged for the AMEX and Nasdaq. We also find that the proportion of even-increment quotes is a relevant factor affecting percentage spreads for Nasdaq both before and after and for the NYSE only after the change in quoting increments.     

The effect of economic policy uncertainty on investor information asymmetry and management disclosures

Investor uncertainty about firm value drives investors’ information collection and trading activities, as well as managers’ disclosure choices. This study examines an important source of uncertainty that likely cannot be influenced by most managers and investors: uncertainty about government economic policy. We find that this uncertainty is associated with increased bid-ask spreads and decreased stock price reactions to earnings surprises. Managers respond to this uncertainty by increasing their voluntary disclosures, but these disclosures only partly mitigate the bid-ask spread increase. We conclude that government economic policy uncertainty is an important component of firms’ information environments and managers’ voluntary disclosure decisions.     

Bid-ask spreads in the market for forward exchange

Recent empirical testing of interest rate parity places a crucial role on the existence of transactions costs in the form of the bid-ask spread. Existing theoretical models tie in the bid-ask spread to exchange rate uncertainty. This paper directs itself to a formal model of the forward exchange market to show that foreign exchange uncertainty per se is not the cause of fluctuating bid-ask spreads. Instead emphasis is placed on relative degrees of absolute risk aversion and the heterogeneity of information sets.     

Liquidity skewness in the London Stock Exchange

We study liquidity on the London Stock Exchange. We find that the average bid-ask spread declines, but that the skewness of the spread increases. These results are robust to firm size, trading volume and price level. Our findings hold when the bid-ask spread is estimated utilising high frequency data. We find that the bid-ask spread prior to earnings announcements dates is significantly higher than that of post earnings announcements, suggesting that asymmetric information has driven the increase in liquidity skewness. We also find that the effect of earnings announcements is more pronounced in the 2007 global financial crisis, consistent with the notion that extreme market downturns amplify asymmetric information. Our overall evidence also implies that increased competition and transparent trading environments limit market makers' abilities to cross-subsidize bid-ask spreads between periods of high and low levels of asymmetric information.     

Bid-ask bounce and speads in the foreign exchange futures market

This paper examines the intraday bid-ask bounce in Deutschemark and Japanese yen futures prices. The intraday Markovian bid-ask bounce process, which leads to a desirable equilibrium condition of reaching a bid or an ask transaction type with equal chances, is identified. A second-order Markov chain transition matrix model is used to derive a generalized estimator of bid-ask spreads in the foreign exchange futures market. It incorporates the conditional probabilities of a subsequent transaction being the same type as the current transaction's () and that of the next transaction being the same as the current type but different from the previous type (). The specification is {-Cov(P _t ,P _t+1 )/[(1–)(–)]}^1/2. The empirical results show that the average implied bid-ask spread is about $10, which is less than one tick's value of $12.50. It is also found that spreads are higher at the beginning and end of the trading day than the rest of the day, reflecting the uncertainty due to information flows and overnight inventory carrying costs, respectively.     

Information Asymmetry Around Earnings Announcements

This study examines bid-ask spreads to determine how the anticipation and release of earnings announcements affect information asymmetry in the stock market. I use regression analysis and find that bid-ask spreads are negatively related to public information availability and positively related to earnings variability and the market reaction to prior unexpected earnings. The results suggest that firms for which earnings is expected to yield a relatively larger stock market reaction have greater information asymmetry than firms for which earnings are expected to yield a smaller market reaction.I also find that bid-ask spreads gradually increase in the four days prior to earnings announcements, and increase sharply the day prior to, the day of and the day after the earnings announcements. Bid-ask spreads seven to ten days after earnings announcements are not significantly different from bid-ask spreads seven to ten days prior to earnings announcements.     

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%     

Changes in REIT Liquidity 1988?C2007: Evidence from Daily Data

In this study, we present panel-data evidence on REIT liquidity and its determinants over the 1988?C2007 period. We focus upon liquidity measures that do not require micro-structure data (1) to facilitate use of our results as benchmarks for comparisons with results from international markets for which micro-structure data may be unavailable, (2) to provide benchmarks that do not require access to costly (and voluminous) micro-structure data. We find that REIT liquidity improved during the early and mid-1990s, deteriorated during the late 1990s, and then improved dramatically during 2000?C2006, with the notable exception of 2007. Liquidity improved the most for REITs traded on the NYSE, and was an order of magnitude better than liquidity of REITs traded on the AMEX or NASDAQ. We link the deterioration in liquidity observed in 2007 to the investment portfolio of a REIT. We find that the percentage bid-ask spread is highly correlated with the measure of price impact proposed by Amihud (2002). We provide panel-data evidence on the key determinants of the percentage bid-ask spread that largely confirms the results reported by Bhasin et al. (1997) for 1990 and 1994: the percentage spread is a positive function of the volatility of stock returns, and a negative function of dollar volume turnover, share price and market capitalization. Finally, we provide evidence that these results obtained using daily closing bid- and ask-prices are not qualitatively different from those obtained using market micro-structure data. This suggests that we can use liquidity measures based upon readily available daily return data rather than being forced to rely upon market micro-structure data.     

The Riskiness of REITs Surrounding the October 1997 Stock Market Decline

Real estate investment trusts (REITs) are viewed as low risk/low return stocks that exhibit defensive stock characteristics. The stock market decline of October 1997 provides an excellent opportunity to examine the riskiness of REITs during high levels of market uncertainty. We find that the decline in REIT stock values was about one-half as large as the decline of non-REIT stocks. Additionally, market uncertainty on the event day was shown with an increased bid-ask spread for all stocks. On the following day when the market decline was partially reversed, the bid-ask spreads continued to increase for non-REIT stocks, but declined for REIT stocks. This suggests that REITs, like defensive stocks in general, are less prone to significant declines during market-wide disturbances. Also, we order stocks based on the standard deviation measures of risk and show that this risk measure explains the cross-section of returns for non-REITs but is not valid for REITs.     

Government intervention and adverse selection costs in foreign exchange markets

An important group of traders in the foreign exchange marketis governments who often adhere to a foreign exchange rate policyof occasional interventions with otherwise floating rates. Inthis article we provide a theoretical model and empirical evidencethat government foreign exchange interventions create significantadverse selection problems for dealers. In particular, our modelshows that the adverse selection component of the foreign exchangespread is positively related to the variance of unexpected interventionand that expected intervention has no impact on the spread.After controlling for inventory and order processing costs,we find that bid-ask spreads increase with U.S. dollar and Germandeutsche mark foreign exchange rate intervention during theperiod 1976-1994. Furthermore, when the intervention is decomposedinto expected and unexpected components, we find a statisticallyand economically significant increase in spreads with the varianceof unexpected intervention, while expected intervention hasno significant impact on spreads.     

Adverse selection, volume and transactions around dividend announcements in a continuous auction system

We show that liquidity providers do not significantly respond to changes in information asymmetry risks, at least when we analyse their trading behaviour around dividend announcements of a representative sample of stocks in a continuous auction trading mechanism. the implicit bid-ask spread does not seem to change beyond what is normally conveyed through an increased number of transactions. We also document that the information in the trading behaviour of investors is primarily contained in the number of daily transactions.     

Earnings Predictability, Information Asymmetry, and Market Liquidity

We investigate the relation between earnings predictability, information asymmetry and the behavior of the adverse selection cost component of the bid-ask spread around quarterly earnings announcements for NASDAQ firms. While we find an increase in the adverse selection component of the bid-ask spread on the day of and the day prior to quarterly earnings announcements for firms with less predictable earnings, we find no evidence of such changes for firms with more predictable earnings. During a non-announcement period, we find that firms with relatively less predictable earnings have consistently higher total bid-ask spreads than firms with more predictable earnings. This finding suggests that firms with relatively less predictable earnings have a higher cost of equity capital than comparable firms with more predictable earning streams, ceteris paribus. Hence, earnings predictability may be a legitimate concern of managers who wish to minimize their cost of equity capital at least as it pertains to bid-ask spreads.