Adverse selection costs: A study on the Chinese stock market |
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Authors: | Chengying He Zonghui Lu Xingqiang He Jun Chai |
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Institution: | (1) Coastal Carolina University, P.O. Box 261954, Conway, SC 29528-6054, USA;(2) Department of Finance, College of Business Administration, Knoxville, TN 37996, USA;(3) College of Business, University of Southern Mississippi, Hattiesburg, MS 39406, USA |
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Abstract: | Employing a bid-ask spread model applicable for order-driven market, this paper decomposes the bid-ask spread of Shanghai
Stock Exchange (SSE) into adverse selection and order processing cost components to investigate the relationship between the
components of bid-ask spread and order size. It examines the impacts of firm size, price, trading activeness, and volatility
on adverse selection cost, and explores the intraday pattern of adverse selection costs and informative trading. Results show
that adverse selection costs increase with trade scale. However, order processing costs do not exhibit the economies of scale.
Stocks of large firms, which are high-priced and actively traded, have relatively low adverse selection costs; stocks with
large volatility have relatively high adverse selection costs. Moreover, this paper finds that the adverse selection component
of bid-ask spread in the Chinese stock market exhibits an L-shaped intraday pattern, which implies that heavy trading around
market opening is dominated by informative trading, while heavy trading near market closing is dominated by liquidity trading. |
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