Bid,ask and transaction prices in a specialist market with heterogeneously informed traders |
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Authors: | Lawrence R Glosten Paul R Milgrom |
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Institution: | Northwestern University, Chicago, IL 60637, USA;University of Chicago, Chicago, IL 60637, USA;Yale University, New Haven, CT 06520, USA |
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Abstract: | The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bid-ask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders. |
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