Bid-ask Spread Research Articles

Trading Volume Shares and Market Quality: Pre- and Post- Zero Commissions

After the adoption of zero-commissions by major brokers, they increasingly route orders to wholesale market makers to possibly earn payment for order flow given the loss of commissions. Retail investors assets held by zero-commission and commission-charging brokers increase 7% and decrease 9%, respectively. Retail investors earn less price improvement per share and submit more orders and smaller orders. Effective spreads decline because retail limit prices are increasingly posted within the bid-ask spread. Intraday volatility increases and price impact falls, as orders become more uninformed, while realized spreads remain unchanged.

A Hierarchical-Dealer-Centric Model of FX Swap Valuation

This paper constructs a model of foreign exchange (FX) swap valuation based on dealers’ behavior and the hierarchy of the global dollar funding system. International investors use these currency derivatives to synthetically fill their US-dollar funding gaps. In this model, three attributes of market structure drive the valuation of FX swaps: market-making costs (measured by dealers’ bid-ask spreads), dollar funding liquidity risk (measured by CIP deviation and market imperfections), and FX swap market liquidity (measured by dealer competition). The goal is to understand how market design influences the cost of US dollar funding and its spillover effects. FX dealers are vital institutions in this ecosystem, as their balance sheets connect national monetary systems to the global dollar funding markets. For currencies with low FX turnover, central banks act as market makers, while private banks serve as dealers for currencies with the highest FX turnover. Studying the “dollar funding gap” through the lens of FX swap dealers is a crucial aspect often overlooked in international finance scholarship.

Inventory, market making, and liquidity in OTC markets

We develop a search-theoretic model of a dealer-intermediated over-the-counter market. Our key departure from the literature is to assume that, when a customer meets a dealer, the dealer can sell only assets that it already owns. Hence, in equilibrium, dealers choose to hold inventory. We derive the equilibrium relationship between dealers' costs of holding assets on their balance sheets, their optimal inventory holdings, and various measures of liquidity, including bid-ask spreads, trade size, volume, and turnover. Using transaction-level data from the corporate bond market, we calibrate the model to quantitatively assess the impact of post-crisis regulations on dealers' inventory costs, liquidity, and welfare.

Dynamic Market Making with Asymmetric Information and Market Power

Abstract We study the dynamics of trading volume and bid-ask spread using a multiperiod trading model with oligopolistic market makers. Traders smooth out their trading even though they are not strategic, and thus trading persists after the arrival of information or liquidity shocks. Traders act quickly on their private information while postponing hedging trades until later periods. The market power of market makers enables them to widen bid-ask spreads when trading incentives are heightened. Consequently, both trading volume and bid-ask spread may exhibit U-shaped patterns. Our model calibration aligns with the empirical intraday patterns observed in bid-ask spreads and trading volumes. (JEL D53, D61, D82, G12, G14, G18)

Deterministic modelling of implied volatility in cryptocurrency options with underlying multiple resolution momentum indicator and non-linear machine learning regression algorithm

Modeling implied volatility (IV) is important for option pricing, hedging, and risk management. Previous studies of deterministic implied volatility functions (DIVFs) propose two parameters, moneyness and time to maturity, to estimate implied volatility. Recent DIVF models have included factors such as a moving average ratio and relative bid-ask spread but fail to enhance modeling accuracy. The current study offers a generalized DIVF model by including a momentum indicator for the underlying asset using a relative strength index (RSI) covering multiple time resolutions as a factor, as momentum is often used by investors and speculators in their trading decisions, and in contrast to volatility, RSI can distinguish between bull and bear markets. To the best of our knowledge, prior studies have not included RSI as a predictive factor in modeling IV. Instead of using a simple linear regression as in previous studies, we use a machine learning regression algorithm, namely random forest, to model a nonlinear IV. Previous studies apply DVIF modeling to options on traditional financial assets, such as stock and foreign exchange markets. Here, we study options on the largest cryptocurrency, Bitcoin, which poses greater modeling challenges due to its extreme volatility and the fact that it is not as well studied as traditional financial assets. Recent Bitcoin option chain data were collected from a leading cryptocurrency option exchange over a four-month period for model development and validation. Our dataset includes short-maturity options with expiry in less than six days, as well as a full range of moneyness, both of which are often excluded in existing studies as prices for options with these characteristics are often highly volatile and pose challenges to model building. Our in-sample and out-sample results indicate that including our proposed momentum indicator significantly enhances the model’s accuracy in pricing options. The nonlinear machine learning random forest algorithm also performed better than a simple linear regression. Compared to prevailing option pricing models that employ stochastic variables, our DIVF model does not include stochastic factors but exhibits reasonably good performance. It is also easy to compute due to the availability of real-time RSIs. Our findings indicate our enhanced DIVF model offers significant improvements and may be an excellent alternative to existing option pricing models that are primarily stochastic in nature.

Capital Market Consequences of Information about Individual Auditors

Synopsis The research problem This study examines the capital market consequences of the voluntary disclosure of individual auditor information. Specifically, we examined whether and how the disclosure of auditor qualification certificates is associated with information asymmetry and investors’ responses to earnings. Motivation Regulators have recently started to focus on disclosing auditor information beyond their names such as in China, where it is increasingly important in practice. Although prior studies have demonstrated benefits associated with the mandatory disclosure of partners’ names, there is relatively little evidence of the usefulness of additional information about individual auditors that could be provided voluntarily. This study sheds light on the economic consequences of disclosing detailed information about individual auditors and extends the voluntary disclosure literature. The test hypotheses We tested the following hypotheses in this study: (a) voluntary disclosure of auditor qualification certificates is associated with lower information asymmetry and (b) voluntary disclosure of auditor qualification certificates is not associated with investors’ reactions to corporate earnings announcements. Target population Stakeholders of listed companies and audit firms, including company managers, investors, and accounting regulators. Adopted methodology Ordinary least squares regressions, archival data, interviews, and machine learning methods to obtain initial data. Analyses We first crawled the annual audit reports of listed companies in China and used machine learning methods to capture voluntary disclosure of auditor qualification certificates. In a sample of more than 14,000 Chinese company-years from 2012 to 2018, we identified 10.5% of the observations voluntarily disclosing auditor qualification certificates. We used the bid-ask spread as the proxy of information asymmetry, and the earnings response coefficient refers to the coefficient on unexpected earnings to the cumulative abnormal returns. Findings We found that the voluntary disclosure of auditor qualification certificates is associated with lower information asymmetry and stronger market reaction to earnings announcements. The main results hold through various robustness tests. Cross-sectional analyses show that this association is less pronounced when a company employs a larger audit firm or has higher analyst coverage. Further, the specific information conveyed by the auditor qualification certificate, such as the auditor’s facial trustworthiness, helps explain the economic consequences associated with voluntary auditor qualification certificate disclosure. Moreover, an initial disclosure of auditor qualification certificates is associated with greater effects.

Dollar and government bond liquidity: Evidence from Korea

Using unique tick-by-tick data from an exchange, this paper examines the relationship between the US dollar and liquidity in the Korean government (Treasury) bond market. We find that a strong US dollar deteriorates the Treasury market's liquidity by increasing the bid-ask spread and the price impact and lowering market depth. The effects of fluctuations in the broad US dollar index on Treasury market liquidity become more pronounced when funding liquidity conditions are tighter, when banks' total capital ratio is lower with greater foreign currency risk, or when there is a larger sell-off of Korea Treasury bonds by foreign investors. The empirical evidence supports the financial channel of exchange rates affecting Treasury market liquidity. In particular, a strong dollar as a barometer of global financial conditions is likely to limit the market intermediation capacity of emerging market dealers and thus tighten emerging market conditions.

Voluntary disclosures by activist investors: the role of activist expectations*

Activist investors in a firm often voluntarily release information about their governance intentions to the public. Voluntary disclosure theory suggests that an activist investor will disclose when she expects other investors to respond positively and support her in upcoming corporate control contests. We find that activists’ disclosures are accompanied by positive abnormal returns, reductions in bid-ask spreads, and increases in future earnings relative to similar targets without voluntary activist disclosures. Disclosures by activists who demand a board seat (the most common demand) have the highest announcement returns, and disclosers also win proxy contests and directorships more frequently than non-disclosers. These findings suggest that the activist’s beliefs about investor response in both pricing and voting are an important driver of her disclosure choice.

Analysis of Investor Reactions to The Right Issue at The IDX Before and During Covid-19

The COVID-19 pandemic has resulted in fluctuations in movement stock prices, and greatly influenced economic conditions as well as reactions of investors regarding the rights issue policy which will influence buying and selling interest shares. The rights issue is an event where information is published as an announcement that can be used to see market reactions. This research was conducted to analyze investor reactions to the Rights Issue announcement. Using 50 samples of companies that carried out rights issues during 2017 - 2020. The inquiry about was carried out utilizing the occasion consider strategy with an advertising show approach. The ordinariness test is the Kolmogorov – Smirnov test. The statistical test used in this research is the difference between two means tests (Wilcoxon Signed Rank Test). The comes about of this inquiry appears that there's a noteworthy contrast in excess returns within the period sometime recently and after the declaration of the rights issue, be that as it may, this inquiry appears that there's no distinction in stock liquidity sometime recently and after the declaration of the rights issue. there's no distinction between the bid-ask spread sometime recently and after the declaration of the rights issue, both sometime recently and amid the widespread COVID-19 implies that the declaration of the rights issue cannot be utilized as a reference choice in an exertion to extend the liquidity of the company offers within the long-term brief, this can be since the declaration of the rights issue isn't sufficient contains data that can impact venture choices.

Price elasticity of demand and risk-bearing capacity in sovereign bond auctions

Abstract The paper uses bids submitted by primary dealer banks at auctions of sovereign bonds to quantify the price elasticity of demand. The price elasticity of demand correlates strongly with the volatility of returns of the same bonds traded in the secondary market but only weakly with their bid-ask spread. It predicts same-bond post-auction returns in the secondary market, even after controlling for pre-auction volatility. The evidence suggests that the price elasticity of demand is associated with the magnitude of price pressure in the secondary market around auction days and proxies for primary dealer risk-bearing capacity.

The impact of designated market-makers on liquidity in frontier markets

Many exchanges around the globe have implemented market-making schemes inan attempt to mitigate liquidity risk and enhance trading volume. This researchexamines the impact of designated market makers on stock liquidity in frontiermarkets, specifically measured by bid-ask spreads and trading turnover. Using adifference-in-differences analysis, we studied 19 stocks that introduced designatedmarket makers at the Zagreb Stock Exchange and Ljubljana Stock Exchangebetween May 2010 and January 2022. To the best of our knowledge, this is the firststudy investigating the impact of market makers in these specific markets and onlythe second in frontier markets overall. As expected, we find a significant reductionin bid-ask spreads for most stocks following the introduction of market makers.However, unlike findings of studies conducted in more developed markets, ourresults for turnover are not conclusive, suggesting that market makers alone maynot be sufficient to overcome structural impediments to market liquidity in frontiermarkets, such as lack of free float and the dominance of large investors with long-term investment horizons.

Liquidity score and bid-ask spread nexus: Empirical researchon exchange traded bonds

Liquidity score and bid-ask spread nexus: Empirical researchon exchange traded bonds

The Geography of Investor Attention

Abstract Local companies attract significantly more attention from investors than nonlocal companies, especially at times of news releases and high volatility. This attention gap widens especially when news is firm-specific rather than aggregate, and in response to idiosyncratic rather than market risk. Attention is causally related to perceived proximity: after a firm is acquired by a nonlocal one, local investors, compared with nonlocal investors, are more likely to reallocate attention away from it; conversely, COVID-19 travel restrictions led investors to reallocate attention toward local companies and away from nonlocal ones, especially those difficult to reach. Finally, local attention predicts volatility, bid-ask spreads, and nonlocal attention, but not vice versa. Our findings suggest that the geography of attention matters and is shaped by local investors’ information-processing advantage, not familiarity bias. (JEL D83, G11, G12, G14, L86, R32) Received: 2 January 2024; Editorial decision: 13 March 2024 Editor: Isil Erel Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Market consistent bid-ask option pricing under Dempster-Shafer uncertainty

We refer to the discrete-time market model under ambiguity introduced in [Cinfrignini, A., Petturiti, D. and Vantaggi, B., Dynamic bid–ask pricing under Dempster-Shafer uncertainty. J. Math. Econ., 2023a, 107, 102871], formed by a frictionless risk-free bond and a non-dividend paying stock with bid-ask spread. For a European derivative, we generalize the classical binomial pricing formula by allowing for bid-ask prices and investigate the properties of the ensuing replicating strategies. Next, for an American derivative, we propose a backward bid-ask pricing procedure and prove that the resulting discounted price processes are the bid-ask Choquet-Snell envelopes of the discounted payoff process, respectively. Moreover, for an American call option, we prove a generalization of the well-known Merton's theorem [Merton, R.C., Theory of rational option pricing. Bell J. Econ. Manage. Sci., 1973, 4, 141–183] holding for both the bid and the ask price processes. Finally, we introduce a market consistent calibration procedure and show the use of the calibrated model in bid-ask option pricing.

MARKET EFFICIENCY AND STABILITY IN THE ERA OF HIGH-FREQUENCY TRADING: A COMPREHENSIVE REVIEW

This comprehensive review analyzes the impact of high-frequency trading (HFT) on market efficiency and stability, synthesizing insights from 50 peer-reviewed articles, industry reports, and regulatory documents. High-frequency trading, which leverages sophisticated algorithms and high-speed data networks, has significantly transformed financial markets. The review confirms that HFT enhances market efficiency by providing liquidity and facilitating rapid price discovery, contributing to tighter bid-ask spreads and lower transaction costs. However, it also highlights several challenges, including market fragmentation, increased volatility, and potential for market manipulation. The review examines how HFT can exacerbate market instability and systemic risks, as demonstrated by incidents like the 2010 Flash Crash. It underscores the importance of robust risk management practices and regulatory measures to mitigate these risks and enhance market resilience. While current regulatory frameworks have had some success, continuous adaptation is necessary to keep pace with rapid technological advancements. Additionally, the review points to the potential of AI and machine learning in improving market surveillance and risk management. Ultimately, the findings suggest that a balanced approach to regulation and innovation is crucial to maximizing the benefits of HFT while ensuring market integrity and stability.

Impact of covered warrant issuance on underlying stocks of listed companies in Vietnam

Nowadays, covered warrants (CWs) have emerged as a popular financial instrument in the Vietnamese stock market, offering investors promising opportunities for profitable returns. However, these instruments also carry inherent risks, necessitating a thorough understanding of their characteristics. This research aims to evaluate the impact of CW issuance on the price and liquidity (measured by trading volume and bid-ask spread) of underlying stocks on the Vietnamese stock market. The study employs the event study methodology and Wilcoxon test to examine whether abnormal returns, trading volume, and bid-ask spreads change after CW issuance. The research uses secondary data of 113 active CWs, based on 20 underlying stocks listed on HNX and HOSE and are issued from April 2023 to January 2024. The findings reveal no significant change in abnormal returns; however, trading volume and bid-ask spreads exhibit noticeable alterations following CW issuance. These results provide valuable insights for investors to consider relevant factors when making informed investment decisions.

Do Reported Intangible Assets Create a Better Information Environment?

Purpose: This study investigates whether the identifiable intangible assets (IIA), goodwill (GW), and research and development expense (R&D) reported in the financial statements and annual reports of firms on the Stock Exchange of Thailand (SET) can improve the information environment, as represented by a narrower bid-ask spread in the capital market. Additionally, this study explores the impact of intangible asset disclosure scores on the information environment. Design/methodology/approach: This study tests the association between reported intangible assets, intangible asset disclosure score, and bid-ask spread. The sample is 2,691 firm-year observations in SET from 2012-2021, and ordinary least squares (OLS) regression is used to test the hypothesis. Findings: The results found that IIA and R&D are associated with the information environment. It is reported that IIA and bid-ask spread have a positive relationship, whereas R&D and bid-ask spread have a negative relationship. In addition, the intangible asset disclosure score can also reduce bid-ask spread. Research limitations/implications: This study highlights the benefits of intangible assets, which can help bridge the information gap. However, the intangible asset disclosure score is determined through self-index construction. This process involves discretion and may be prone to errors. Furthermore, using the bid-ask spread as the sole indicator of the information environment might be inadequate. Originality/value: Research on information asymmetry about intangible assets in Thailand is scarce. This study provides empirical evidence to support the benefit of some intangible assets in reducing asymmetric information among investors. By utilizing the intangible asset disclosure score, including mandatory and voluntary disclosure, it is also possible to observe how different disclosure quality levels impact the information environment.

IPO comment letter responses and stock price volatility in the STAR market

ABSTRACT The public disclosure of IPO comment letter responses represents a significant institutional innovation within the registration-based IPO system. This study investigates the impact of IPO comment letter responses on post-IPO stock price volatility. Our findings indicate that both the quantity and quality of information in issuer responses are inversely correlated with stock price volatility. Additionally, this impact is pronounced when issuers invest more in R&D or face higher operational risk. Mechanism tests suggest that response information quantity (quality) is positively associated with changes in the information quantity (quality) of final-version prospectuses, while negatively correlated with informed trading and bid-ask spread. Lastly, we observe a diminishing effect of responses on post-IPO stock price volatility as time passes. These findings have implications for issuers to mitigate stock volatility risk and for regulators to advance reforms in the registration-based IPO system.

Eleven sectors’ reaction to the political event 2023: evidence from Indonesia Stock Exchange

Research aims: This study analyzes the differences in market reaction towards eleven sectors in the Indonesia Stock Exchange (IDX) during the political event, i.e., the announcement of the Indonesian presidential and vice-presidential nominees in 2023.Design/Methodology/Approach: This study applied the event study method with indicators of abnormal return, trading volume activity, security return variability, and bid-ask spread. The hypothesis test was a non-parametric test by Wilcoxon Signed Rank Test with a window period of seven days of observation (-3, 0, +3).Research findings: The Wilcoxon Signed Rank Test results revealed a mixed reaction by eleven sectors in IDX to this political event, in which there was a difference and no difference in the reactions.Theoretical contribution/Originality: This study contributes to providing insight into the reaction of eleven different sectors in the IDX to the different announcements of the Indonesian presidential and vice-presidential nominees in 2023. Previous research usually focused on stock indices or only testing one particular sector. Hence, this study investigated eleven sectors in the capital market to compare the different reactions and to expand the results.Practitioner/Policy implication: Research on capital market reactions to political events provides important information for investors to make investment decisions based on investor sentiment that assesses the electability of prospective heads of state to advance the Indonesian economy.Research limitation/Implication: The scope of this study is the announcement of the Indonesian presidential and vice-presidential nominees in 2023; future researchers can continue research on capital market reactions to the Indonesian presidential election 2024 events and add relevant variables, such as foreign sales and foreign buys.

Analysis of Differences in Stock Trading Volume, Bid-Ask Spread, and Abnormal Returns Before and After a Stock Split: Empirical Evidence from Companies Listed on the Indonesian Stock Exchange

Analysis of Differences in Stock Trading Volume, Bid-Ask Spread, and Abnormal Returns Before and After a Stock Split: Empirical Evidence from Companies Listed on the Indonesian Stock Exchange