Abstract
Using quote data for stocks from the Saudi Stock Market (SSM), this paper empirically examines the hypothesized spread behavior predicted by Handa, Schwartz and Tiwari (1999) model. The model predicts that, in an order driven market, the bid-ask spread is a positive function of (1) differences in valuation among investors and (2) adverse selection. The model also implies that the bid-ask spread is concave function of the proportion of buyers in the market. Consistent with this model, we find that both the spread and of the relative spread variables follow an inverted U-pattern, being low when the market is concentrated on one side and high when the proportion of buy orders is close to one-half. The results on the correlation between the two variables also validate the implications of the model. However, the findings of our attempt to test the model prediction using the Generalized Method of Moments (GMM) fail to provide the same support.
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