Does Risk Aversion Vary During the Year? Evidence from Bid-Ask Spreads

Abstract

We document previously undiscovered seasonal patterns in bid-ask spreads which are economically and statistically significant. After controlling for well-known conditional effects on spreads, such as risk, liquidity, and asymmetric information effects, we find that spreads based on individual dealer quotes are on average 20 basis points wider during the fall and winter relative to their unconditional average of 180 basis points. Furthermore, inside spreads are about 20 basis points narrower during these periods when spreads based on individual quotes are wider. We posit that these opposing patterns in quoted spreads and inside spreads are the logical outcome of seasonally changing risk aversion among a subset of market makers. When we consider periods of high market volatility, we find that the economic and statistical significance of the seasonal patterns in spreads intensify, as they should if they arise for reasons related to risk aversion. Our findings are robust to a wide range of tests and specification changes. Independent of the cause, researchers studying spreads need to be mindful of the strong seasonal patterns in individual dealer spreads and inside spreads, as does any market participant who has discretion in the timing of his trades.