THE DEALER AND MARKET CONCEPTS OF BID-ASK SPREAD: A COMPARISON FOR NASDAQ STOCKS

Two models of bid-ask spread are estimated with a unique sample of matched observations of dealer spreads and market (inside) spreads for NASDAQ stocks. The estimates demonstrate that dealer and market spreads relate differently to their common determinants, indicating that the two measures are not interchangeable. Consequently, studies must select the spread concept that is appropriate to the hypothesis being tested to get unbiased estimates and correct interpretations of model parameters. In particular, the cost of immediacy to investors is measured directly by market spreads, while market-making costs and interdealer competition relate directly to dealer spreads.     

INTRADAY VARIATIONS IN TRADING ACTIVITY,PRICE VARIABILITY,AND THE BID-ASK SPREAD

In this paper intraday variations in trading activity and the bid-ask spread are examined. Intraday variations in volume and price variability demonstrate a U-shaped pattern as in previous studies. However, I find a U-shaped pattern for a measure of the spread component that is related to the degree of information asymmetry between the specialist and informed traders and an inverted U-shaped pattern for the other spread component related to inventory and order costs. Two alternative explanations are given.     

TRADING OF NASDAQ STOCKS ON THE CHICAGO STOCK EXCHANGE

We use a linear programming model to form two portfolios with approximately equal levels of attributes such as financial leverage. One portfolio comprises stocks that trade exclusively on NASDAQ and the other, stocks that trade on both the Chicago Stock Exchange (CSE) and NASDAQ (CSE/NASDAQ). We find that spreads are lower for the CSE/NASDAQ portfolio, but so is the percentage of quotes at spreads of $0.125. In fact, the lower spreads observed for the CSE/NASDAQ portfolio arise from fewer quotes with spreads of more than $0.25.     

MARKET STRUCTURE AND REPORTED TRADING VOLUME: NASDAQ VERSUS THE NYSE

Trading volume for common stocks is of interest to financial economists, investors, and securities lawyers. NASDAQ is a dealer market where trades with dealers are included in reported trading volume. This procedure does not accurately measure the trading volume by public buyers and sellers. Trading volume reported on the NYSE, which is primarily an auction market, provides a much closer measure of trades by public investors. We examine a sample of firms whose stock traded on the NASDAQ/NMS and subsequently on the NYSE. When trading switches to the NYSE, the firms' trading volume drops to about 50 percent of the volume previously reported on NASDAQ. A control group of firms that switched from the AMEX to the NYSE shows a small, but statistically insignificant, increase in trading volume.     

THE OVER-THE-COUNTER MARKET AND NEW YORK STOCK EXCHANGE TRADING HALTS

This paper examines the over-the-counter (OTC) market activities for stocks temporarily suspended by the New York Stock Exchange (NYSE). Unlike previous studies, we use transaction-to-transaction data on the NASDAQ during NYSE trading halts to investigate the price adjustment process between market equilibria. The evidence indicates that while being halted by the NYSE, the same stocks have exhibited significantly greater volatility in the OTC market. Since the volatile price movement is mainly random and provides no arbitraging opportunities for the OTC market traders, we do not find support for the proposal that trading halts should be mandatory for all trading locations.     

INTRADAY CHANGES IN TARGET FIRMS' SHARE PRICE AND BID-ASK QUOTES AROUND TAKEOVER ANNOUNCEMENTS

This paper documents changes in share prices, bid-ask spreads, and quote sizes for target firms during the day a takeover proposal is announced. The mean 21.2 percent announcement-day return consists primarily of a 19.5 percent return at the announcement. There is little evidence that spreads increase before the announcement, except when trading is suspended because of an order imbalance. Quote sizes show some sign of decreasing just before the announcement. The quoted bid-ask spread and size increase immediately after the announcement, but spreads quickly return to normal.     

OPEN MARKET STOCK REPURCHASE PROGRAMS AND LIQUIDITY

In this paper I examine the behavior of bid and ask spreads and depths around announcements of open market stock repurchase programs. For a sample of 195 announcements from 1988 to 1990, I find statistically significant evidence of a small decline in spreads and no evidence of a shift in depths following the announcement date. Results are similar for a subsample of firms experiencing post-announcement declines in the number of shares outstanding. I conclude that open market repurchase programs as used recently do not adversely affect market liquidity.     

TRADE SIZES AND THEORIES OF THE BID-ASK SPREAD

Relations between trade-size characteristics and the bid-ask spread are developed to distinguish among major theories of the spread. These trade-size characteristics are determinants of the spread for NASDAQ/NMS stocks. They explain much of the cross-sectional variation in the spread commonly associated with volume, volatility, and share price. Evidence shows that order-processing costs are dominant relative to inventory effects for low-price, small-capitalization, and low-volume stocks, but that the opposite is true for high-price, large-capitalization, and high-volume stocks. Inventory effects are more important relative to asymmetric information costs when stock price or capitalization is lower.     

A MICROSTRUCTURE ANALYSIS OF THE LIQUIDITY IMPACT OF OPEN MARKET REPURCHASES

We examine the liquidity impact of Canadian open market repurchases and find that spreads are smaller and depths greater during repurchase programs (as compared to the prerepurchase period) and on repurchase days (as compared to nonrepurchase days). We examine the types of orders used by repurchasing companies and find that all repurchase orders are limit orders and more than 70% of these unambiguously add liquidity to the limit order book. The improved liquidity is consistent with U.S. research but different from results from other markets. We attribute the difference to an uptick restriction that limits the aggressiveness of North American repurchases.     

TRADING PATTERNS OF SMALL AND LARGE TRADERS AROUND STOCK SPLIT EX-DATES

We investigate the trading patterns of small and large traders around stock split ex-dates. Using the intraday transaction database for the Toronto Stock Exchange during 1983–89, we find that stock splits are associated with significant changes in trading patterns. Although stock splits appear to have little effect on the trading behavior of large traders (trade value of at least $100,000), they are associated with significant decreases in odd-lot trading and increases in small board-lot trading (trade value of less than $10,000). Although the liquidity premia decrease for all trade sizes, trade direction changes significantly from sell to buy after split ex-dates for all but the large trades, where the change is in the opposite direction. The significant increase in variances after split ex-dates is explained by various microstructure-related variables, and small (large) trades appear to be (de)stabilizing.     

MARKET TIMING OF INTERNATIONAL STOCK MARKETS USING THE YIELD SPREAD

We use probit modeling to forecast bear stock markets in the United States and in eight major foreign stock markets. In general, we find that the U.S. yield spread contains more important market‐timing information than does the home‐country yield spread for profitable market timing. At a 35% probability screen, our simulations show that the U.S. dollar (representative local currency) investor could earn a median compound annual return across eight foreign (non‐U.S.) stock markets of 15.75% (17.67%) by following a market‐timing strategy versus a median buy‐and‐hold return of 13.56% (16.55%).     

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.     

OPEN MARKET REPURCHASES: THE VALUE FROM BUYING SHARES AT A DISCOUNT

This article shows that share repurchase announcements create value for shareholders when the shares of the industrial firm sell at a discount from the value of the underlying assets, even when shareholders and managers share full information about the firm's prospects and the firm's operating performance is not expected to improve. The value created by capturing the discount on the repurchased shares is a function of only two variables: the percentage discount prior to the announcement and the proportion of shares to be repurchased.
For a sample of 100 companies selling below net asset value, the authors report that the excess stock returns surrounding their announcements of open market repurchases are (significantly) positively associated with the authors' estimates of the value captured from buying shares at a discount. Moreover, the stock market's response to repurchase announcements by companies that are selling at a discount is considerably more positive than to announcements by firms selling at a premium.     

STOCK MARKET SIGNALS OF CHANGES IN EXPECTED INFLATION

This paper examines the relationship between stock returns and several measures of expected inflation. The proxies include the inflation forecasts extracted from U.S. Treasury bill yields, the mean forecast of surveys conducted by the Institute for Social Research, and the predictions from a rolling time-series model. Unlike recent studies, there does not appear to be a significant negative relationship between stock returns and expected inflation at the beginning of the period. The results are consistent with the hypothesis that stock returns signal changes in expected inflation.     

THE DETERMINANTS AND DYNAMICS OF BID-ASK SPREADS ON THE LONDON STOCK EXCHANGE

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.