BID-ASK SPREAD COMPONENTS IN AN ORDER-DRIVEN ENVIRONMENT

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.     

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.     

BID-ASK SPREAD AND OWNERSHIP STRUCTURE

In this paper we examine the relation between bid-ask spread and ownership structure variables based on 1985 data for 1,063 NYSE firms. We document a nonpositive relation between bid-ask spread and insider ownership and conclude that spread is unrelated to insider trading. We also find a robust significantly negative relation between spread and institutional ownership. Finally, we find a positive but generally insignificant relation between spread and blockholdings. Overall, our evidence does not support the predictions of asymmetric information models in markets with anonymous trading.     

INFORMED TRADING RISK AND BID-ASK SPREAD CHANGES AROUND OPEN MARKET STOCK REPURCHASES IN THE NASDAQ MARKET

Microstructure theory contends that dealers' bid-ask spreads should vary intertemporally with changes in the asymmetric information component of the spread. Corporate theory suggests that stock repurchase announcements signal management's private information to the securities markets. An examination of dealers' spread behavior around firms' open market repurchases in the NASDAQ market reveals a decline in spreads adjusted for dealers' inventory-holding and order-processing costs. This decline is attributed to a reduction in informed trading risk associated with the open market repurchase announcements.     

A SIMPLE MODEL OF BID-ASK SPREAD AND SEARCH

This paper analyzes a simple search model of market making in which the agents can choose between searching for a trading partner or trading through the market-maker. Explicit solutions for the equilibrium search intensities and the bid-ask spread have been provided. Equilibrium search intensities and the bid-ask spread reflect the strategic interaction between the agents and the market-maker: an increase in the bid-ask spread results in higher search intensities. The bid-ask spread, on the other hand, reacts negatively to an increase in the search intensities (due to lower search costs, higher efficiency of search, or higher gains from a match). It is also shown that the introduction of a market-maker increases the seller's reservation price and decreases the buyer's reservation price, hence narrowing the price dispersion.     

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.     

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.     

INTEREST RATE PARITY AND THE BEHAVIOR OF THE BID-ASK SPREAD

We use a stochastic frontier regression model to test interest rate parity (IRP) with bid- ask spreads for the Belgian franc, the Deutschmark, and the Swiss franc. The forward markets tested have become efficient in the sense that IRP holds well. The bounds provided by IRP do not appear to be binding, however. We provide evidence that in spite of the overall goodness of fit of the model, the arbitrage margins are sometimes violated, implying possible arbitrage opportunities. The percentage bid-ask spread is consistently higher for the Belgian franc than for the Deutschmark and the Swiss franc. Spreads are increasing functions of the time to maturity and volatility. Spread-size clustering is more severe than price-level clustering and appears to be inversely related to volatility and positively related to the trading volume. We find no evidence of significant calendar-day effects on spread size.     

AN IMPLICIT MEASURE OF THE EFFECTIVE BID-ASK SPREAD: A NOTE

We extend Roll's study of the effective bid-ask spread in an efficient market environment by allowing for serially correlated order arrival and quote behavior. This extension results in a more general effective bid-ask spread measure, which precludes imaginary spreads and includes Roll's measure as a special case when the serial correlation is zero. This new measure is related to the length of the measurement interval due to the serial correlation, and thus has the potential to explain the previously observed differential between weekly and daily derived spreads.     

A MODIFIED METHOD FOR INFERRING THE EFFECTIVE BID-ASK SPREAD FROM SECURITY RETURNS

This paper presents a modified method for inferring the effective bid-ask spread from security returns in an eMicient market. The Modified Method removes from security returns the systematic effect of market movements and makes use of the equivalence properties of the moving average process and serial covariance function. The Modified Method is tested with the CRSP daily, weekly, and monthly returns data. The results show that the spread estimates are non-negative and sample time-interval independent. The results are compared with those of Roll (1984) and Amihud and Mendelson (1986).     

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.     

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.     

SECURITY PRICE REACTIONS AROUND PRODUCT RECALL ANNOUNCEMENTS

This study presents an empirical, event-time analysis of the financial impact of product recall announcements on the equity holders of affected firms. Product recalls convey relevant information to the market at the time the announcement is reported in The Wall Street Journal. Further, security prices continue to react significantly to product recall announcements for approximately two months following the initial news release. No relation between the firm's equity decline and the direct costs of the recall is found, indicating the importance of indirect costs such as litigation or a reduction in future corporate sales due to reputation damage.     

EMPIRICAL EVIDENCE ON THE IMPACT OF THE BID-ASK SPREAD ON THE CHARACTERISTICS OF CRSP DAILY RETURNS

It is widely recognized that Center for Research in Security Prices (CRSP) returns may differ from “true” returns because of the bid-ask effect. Using a large sample of New York Stock Exchange and American Stock Exchange securities, I confirm a discernible bid-ask effect, the magnitude and importance of which decrease with the security's price level (increase with the spread). I find volatility estimates using CRSP returns to be greater than those based on quote returns. However, market model properties, such as β and R², are generally unaffected. Bid-ask effects are clearly apparent in event studies, but because of certain offsetting effects commonly used test statistics remain unaffected. Low-priced stocks (below $2.00) do not conform to these patterns. Finally, the evidence raises the possibility that the existing literature on filter rule tests may underestimate the bid-ask spread component of transaction costs.     

AN INVESTIGATION OF THE EFFECT OF QUALIFIED AUDIT OPINIONS ON THE TRADING VOLUME AND BID-ASK SPREAD OF OVER-THE-COUNTER FIRMS

This paper investigates the information content of qualified audit opinions. The announcement of a qualified audit opinion is expected to cause investors' beliefs about the firm to converge. This increase in consensus would be evidenced by an unexpected decrease in trading volume surrounding the initial public announcement. Proportional bid-ask spread changes are used to test for changes in information asymmetry due to the announcement. After controlling for the effects of earnings announcements, a significant trading volume reaction is found in the week of the announcement for a sample of firms traded over the counter. No significant difference in proportional bid-ask spread is found. The results suggest that qualified audit opinions do, indeed, convey information to the investing public and this information results in homogeneous beliefs about the firm.     

CHANGES IN TRADING ACTIVITY FOLLOWING STOCK SPLITS AND THEIR EFFECT ON VOLATILITY AND THE ADVERSE-INFORMATION COMPONENT OF THE BID-ASK SPREAD

We examine changes in trading activity around stock splits and their effect on volatility and the adverse-information component of the bid-ask spread. Even after controlling for microstructure biases, we find a significant increase in volatility after the split. Changes in total volatility and in its permanent component are positively related to changes in the number of trades. This suggests that both informed and noise traders contribute to changes in trading activity. Further, while the adverse-information component of the spread increases unconditionally after the split, the change is negatively related to the change in trading activity. The results suggest that a crucial determinant of liquidity changes after a stock split is the success of the split in attracting new trades in the security.     

INSIDER TRADING,REGULATION, AND THE COMPONENTS OF THE BID–ASK SPREAD

In this article we investigate the relation between insider trading regulations and the bid–ask spread. We decompose the spread into its components before and after the enactment of strict new insider trading rules in New Zealand. We find that the enactment led to a significant decrease in the information asymmetry component of the spread, which is observed mainly in illiquid and high prechange information asymmetry companies. These findings are robust to model specification. In addition, we find a decrease in the contribution of information asymmetry to price volatility.     

INSIDER TRADING EFFECTS ON STOCK RETURNS AROUND OPEN-MARKET STOCK REPURCHASE ANNOUNCEMENTS: AN EMPIRICAL STUDY

In this paper we empirically examine the effects of insider trading activities, the percentage of common shares outstanding authorized for repurchase, and management ownership on stock returns around open-market stock repurchase announcements. The study is conducted on a sample of 204 firms that announced open-market stock repurchases between 1982 and 1990. Results show that insider trading activities during the month that immediately precedes the announcement have a significant effect. While stockholders of firms with insider net selling activities earn positive excess returns, those of firms with insider net buying activities earn larger and more significant excess returns. Insider trading activities during more distant periods do not show any effects on stock returns. Results also indicate that management ownership has a significant positive effect on stock returns, and this effect is more positive when the percentage of common shares outstanding authorized for repurchase is large.