Bid-ask Spread Research Articles

Financial transaction tax, liquidity, and informational efficiency: Evidence from Italy

This study investigates whether the liquidity of medium-sized and large caps has been differently affected by the Italian Financial Transaction Tax, among the firms subject to the tax. We evaluate changes in mean and median bid-ask spreads and Amihud (2002) liquidity for aggregate market indexes and at the firm level. After the implementation of the tax, spreads have widened more for medium- than for large-caps, whereas the Amihud liquidity measure remained unaltered for the vast majority of the firms.

Market-based Financing Reforms and Shareholder Valuations: event Study Evidence from the Chinese Sci-Technology Innovation Board

ABSTRACT In this study, the impact of the newly introduced sci-technology innovation board (STAR) on stock valuations in China is examined. Two key event dates are addressed, the STAR guideline announcement date and applicants’ prospectus release dates. The results suggest a positive market reaction of relevant listed firms. The difference-in-differences (DID) results for the first event show a reduction in the bid-ask spreads of high-tech firms, as the new policy attracts more analyst research, particularly in-depth research. The DID results for the second event indicate that the information asymmetry for ownership-related listed firms decreases compared to firms within the same industries.

Рынок обезличенных металлических счетов в России: факторы назначения спреда

Due to economic instability there has been an increase in demand for unallocated metal accounts offered by Russian commercial banks since April 2020. Although opening unallocated metal accounts gives banks an opportunity to expand the range of their products, diversify income, attract new clients and retain old ones, most Russian banks do not provide such services. For those, it is important to understand the determinants of bid-ask spreads (the difference between the quoted metal bid and ask prices), since the demand for unallocated metal accounts and the bank’s income from this service depend on the bid-ask spread. The purpose of this paper is to investigate the main determinants of quoted bid-ask spreads on unallocated metal accounts in commercial banks. Multiple regression models are applied for the period from October 2017 to May 2020. There are very few articles on the determinants of quoted bid-ask spreads on unallocated metal accounts; for this reason the paper is based on the results of studies of bid-ask spreads in other markets. Based on recent theoretical results, which indicate that bid-ask spreads depend on price volatility, we confirm this hypothesis on unallocated metal accounts. Moreover, we reveal that banks’ assets and the share of state participation influence bid-ask spreads on unallocated metal accounts in commercial banks. It is also proven that bid-ask spreads for unallocated metal accounts in gold are, on average, lower than those for palladium, platinum and silver.

Portfolio Inventory Risk of Liquidity Providers: Frictions and Market Fragility

We investigate, for limit order book equity markets, how trading, liquidity provision, and the overall market quality in one security are influenced by correlated inventory risk exposures of liquidity providers to other securities in their portfolios. We find strong support for Ho and Stoll (1983). Our results are also consistent with large and correlated portfolio inventories worsening different measures of market quality – including bid-ask spreads and pricing errors – and increasing the number and likelihood of extreme price movements and transitory jumps in stock returns. We accordingly highlight a significant but often overlooked source of market frictions, contagion, and fragility.

Trading Volume Shares and Market Quality in a Zero Commission World

We find that major retail brokers that eliminate commissions dramatically increase their market share of client assets. Using broker’s SEC Rule 606 reports, we find they increasingly routed orders to off-exchange wholesale market makers instead of exchanges to gain more payment for order flow and to be compensated for the loss of commission revenues. Consequently, wholesale market makers’ volume increases relative to exchanges. In the retail brokers’ trade-off between payment for order flow versus price improvement, retail investors receive less price improvement per share. Zero commissions traders switch to odd lots and smaller order size buckets. Overall market quality improves. Effective spreads decline because retail investors post many more standing orders inside the bid-ask spread. Realized spreads are unchanged but intraday volatility increases suggesting that the new orders are relatively uninformed.

Determinant Factors of Liquidity Risk Premium on Indonesian Government Bonds

This paper aims to find the determinant factors of the liquidity risk premium on the Indonesian government bonds. There are two liquidity risk premium proxies to be used, the difference of the yield to maturity and the theoretical-yield of the bonds, and the average bid-ask spread of the bonds. The research used the Random Effect panel-data to define the determinant factors of the liquidity risk premium. The result shows that the liquidity-risk premium of Indonesian government bonds is affected by the bond’s characteristics and the financial market condition. The determinant factors are the bond’s age, coupon rate, remaining life, issued amount, type (Sukuk or conventional), and market volatility. We expect this research will enrich the understanding of the liquidity risk on Indonesian government bonds; so that the authorities and the investors could use this in making their decisions.

Liquidity Pricing in Emerging Market Corporate Bonds

This paper examines liquidity pricing in emerging market corporate bonds that are traded in the US market. Average market-wide effective bid-ask spreads are 0.51%, and rise to 1.12% during the financial crisis. Using time series regressions, we find that portfolios with illiquid bonds perform worst when market liquidity deteriorates. Fama-MacBeth regressions with forward looking expected returns as the dependent variable show evidence in favor of a negatively priced liquidity risk factor, which is in accordance with standard theory. Portfolio characteristics proxying for the liquidity level are also important determinants of the cross-sectional variation in expected returns of emerging market corporate bonds, and reduce the effect of the liquidity risk factor. The results for a matching sample of US bonds show a different pattern: with only market risk and liquidity risk factors, the price of liquidity risk is counter-intuitively positive. When controlling for liquidity level proxies, the liquidity risk premium vanishes for the US bonds.

Time to clean up environmental liabilities reporting: disclosures, media exposure and market implications

ABSTRACT We investigate firms’ disclosures related to environmental liabilities (EL), how these vary with media exposure, and whether they have information content. Using a sample of European-listed firms reporting under IFRS from 2005 to 2016, we observe diversity in disclosure practices across industries and regions. Although there is an increasing disclosure trend, the level of disclosure of key inputs used to estimate EL (i.e. discount rates and horizons) remains low, with only 35% of firm-years with material EL containing disclosures of both inputs. Furthermore, we test and find that firms facing more media exposure related to environmental matters provide disclosures that are more specific and are more likely to disclose discount rates. Finally, we show that EL disclosure specificity is associated with lower bid-ask spreads following the filing of the annual report and reduced analyst forecast error and dispersion, suggesting specific disclosure reduces information asymmetry.

The Importance of Investor Heterogeneity: An Examination of the Corporate Bond Market

Corporate bond market participants are increasingly worried about liquidity. However, bid-ask spreads and other standard measures indicate liquidity has not deteriorated significantly. This paper proposes a potential reconciliation. We show the sensitivity of credit yields to bid-ask spreads increased fourfold from 2005 to 2019. We then provide a model that connects this change to the rapid growth of mutual funds in the corporate bond market. The model features heterogeneous investors with different trading needs who choose between a risk-free asset and illiquid bonds. As the risk-free rate declines, more short-term investors reach for yield and enter the bond market. These short-term investors reduce the selling pressure in each sub-market and so the bid-ask spreads. However, their greater trading needs amplify the sensitivity of credit yields to the bid-ask spreads, leading to a larger liquidity component. We next test the model’s predictions using detailed data on investor holdings in the U.S. As predicted, we find investor turnover is associated with larger effects of illiquidity on credit yields. Bonds with more short-term investors are traded at lower bid-ask spreads, but their credit yields are more sensitive to the bid-ask spreads. Finally, we look across countries and show that, consistent with the model, larger declines in risk-free rates are associated with higher growth in mutual fund shares. These results highlight the key role that investor heterogeneity plays in determining how liquidity is priced into corporate bond yields and firms’ financing conditions.

Asset Market Liquidity Risk Management Using Machine Learning Techniques

Asset market liquidity risk is a significant and perplexing subject and though the term market liquidity risk is used quite chronically in academic literature it lacks an unambiguous definition, let alone understanding of the proposed risk measures. To this end, this paper presents a review of contemporary thoughts and attempts vis-a-vis asset market/liquidity risk management. Furthermore, this research focuses on the theoretical aspects of asset liquidity risk and presents critically two reciprocal approaches to measuring market liquidity risk for individual trading securities, and discusses the problems that arise in attempting to quantify asset market liquidity risk at a portfolio level. This paper extends research literature related to the assessment of asset market/liquidity risk by providing a generalized theoretical modeling underpinning that handle, from the same perspective, market and liquidity risks jointly and integrate both risks into a portfolio setting without a commensurate increase of statistical postulations. As such, we argue that market and liquidity risk components are correlated in most cases and can be integrated into one single market/liquidity framework that consists of two interrelated sub-components. The first component is attributed to the impact of adverse price movements, while the second component focuses on the risk of variation in transactions costs due to bid-ask spreads and it attempts to measure the likelihood that it will cost more than expected to liquidate the asset position. We thereafter propose a concrete theoretical foundation and a new modeling framework that attempts to tackle the issue of market/liquidity risk at a portfolio level by combining two asset market/liquidity risk models. The first model is a re-engineered and robust liquidity horizon multiplier that can aid in producing realistic asset market liquidity losses during the unwinding period. The essence of the model is based on the concept of Liquidity-Adjusted Value-at-Risk (L-VaR) framework, and particularly from the perspective of trading portfolios that have both long and short trading positions. Conversely, the second model is related to the transactions cost of liquidation due to bid-ask spreads and includes an improved technique that tackles the issue of bid-ask spread volatility. As such, the model comprises a new approach to contemplating the impact of time-varying volatility of the bid-ask spread and its upshot on the overall asset market/liquidity risk using machine learning techniques.

Inflexible Prices and Information Frictions

Firms' inflexibility in adjusting output prices to input-cost shocks exacerbates information asymmetry between firm insiders and outsiders, but the government's disclosure of economic statistics mitigates this problem. We measure the public visibility of firms' input costs using a combination of production network and publication of producer-price indices by the Bureau of Labor of Statistics (BLS). Input-cost visibility reduces inflexible-price firms' probability of informed trading, the bid-ask spread, option-implied volatility, and analyst forecast dispersion, but these results do not hold for flexible-price firms. During conference calls hosted by inflexible-price firms, outsiders are less likely to ask questions about future input costs if the firm's input cost is more publicly available. To establish causality, we exploit an exogenous coverage expansion by the Office of Publications at BLS in January 2004.

Efficient Estimation of Bid-Ask Spreads from Open, High, Low, and Close Prices

We propose a novel estimation procedure of bid-ask spreads from open, high, low, and close prices. Our estimator is asymptotically unbiased and optimally combines the full set of price data to minimize the estimation variance. When quote data are not available, our estimator generally delivers the most accurate estimates of effective bid-ask spreads numerically and empirically. The estimator is derived under permissive assumptions that allow for stylized facts typically observed in real market data, is easy to implement, and can be applied to liquid and illiquid market segments, both in low and high frequency.

Valuation of bid and ask prices for European options under mixed fractional Brownian motion

<abstract> In this paper, we study the valuation of the bid and ask prices for European options under the mixed fractional Brownian motion with Hurst index $ H &gt; 3/4 $, which is able to capture the long range dependence of the underlying asset returns in real markets. As we know, the classical option pricing theories are usually built on the law of one price, while ignoring the impact of market liquidity on bid-ask spreads. The theory of conic finance replaces the law of one price by the law of two prices, allowing for market participants sell to the market at the bid price and buy from the market at the higher ask price. Within the framework of conic finance, we then derive the explicit formulas for the bid and ask prices of European call and put options by using WANG-transform as a distortion function. Moreover, numerical experiment is performed to illustrate the effects of the Hurst index and market liquidity level on bid and ask prices. </abstract>

The Geography of Investor Attention

Retail investors pay over twice as much attention to local companies than non-local ones, based on Google searches. News volume and volatility amplify this attention gap. Attention appears causally related to perceived proximity: first, acquisition by a nonlocal company is associated with less attention by locals, and more by nonlocals close to the acquirer; second, COVID-19 travel restrictions correlate with a drop in relative attention to nonlocal companies, especially in locations with fewer ights after the outbreak. Finally, local attention predicts volatility, bid-ask spreads and nonlocal attention, not viceversa. These findings are consistent with local investors having an information-processing advantage.

A Model of Strategic High-Frequency Trading and For-Profit Exchanges with Intentional Delays

This paper studies competition between strategic high-frequency traders (HFTs) and multiple for-profit exchanges. In the model, HFTs play a dual role as liquidity snipers and market makers and strategically decide on their trading venue, the intensity of market monitoring, a bid-ask spread, and speed technologies. With the strategic liquidity provision and HFTs' dual role in the market, I show that the expected bid-ask spread can shrink when adverse selection becomes more severe. I also derive the HFTs' demand for speed services and demonstrate that it can be an increasing function of the length of intentional delays imposed on trade execution by exchange platforms (e.g., speed bumps). In the second part, for-profit exchanges try to maximize their revenues from supplying speed services to HFTs by controlling the speed of order execution. Since the demand for speed services can positively react to the intentional delays in order execution, exchanges are willing to introduce them to boost their profits. Thus the imposition of delays, which mitigates adverse selection and improves liquidity, is supported as an equilibrium outcome even without government intervention.

A comprehensive study on bid-ask spread and its determinants in India

Determinants of bid-ask spread have been explored significantly for low-frequency datasets in many developed markets. Researchers have identified share price, traded volume, market–capitalization, ...

Private Information Dissemination in the Secondary Loan Market: The Effect on Stock Bid-ask Spreads

We consider loans being marked to market to constitute new information that is only immediately available to large institutional traders, so-called qualified institutional buyers (QIBs). Smaller investors (non-QIBs) do not have instant access to such information. Investigating the effects of privileged information releases on bid-ask spreads of borrowing firms’ equity, we find a significant elevation in the level of information asymmetry that affects those spreads. Our paper reveals that private information dissemination in the secondary loan market affects the stock market information environment and yields benefits to large insiders with priority access to important information about the borrowing firms’ quality.

A Structural Model of Market Friction with Time-Varying Volatility

We propose a model of price formation in which the trading price varies only if the value of the information signal is large enough to guarantee a profit in excess of transaction costs. Using transaction data only, we extract: (i) the conditional volatility of the underlying security, which is thus cleaned out by market frictions, (ii) an estimate of transaction costs. Our analysis reveals that, after correcting for frictions, the risk of illiquid securities is substantially different from what predicted by traditional volatility models. Furthermore, in periods of high volatility, our estimate of transaction costs remains highly correlated with bid-ask spreads, whereas alternative illiquidity proxies, such as the fraction of zero returns, loose their explanatory power.

Phase Transitions in Kyle's Model with Market Maker Profit Incentives

We consider a stochastic game between three types of players: an inside trader, noise traders and a market maker. In a similar fashion to Kyle's model, we assume that the insider first chooses the size of her market-order and then the market maker determines the price by observing the total order-flow resulting from the insider and the noise traders transactions. In addition to the classical framework, a revenue term is added to the market maker's performance function, which is proportional to the order flow and to the size of the bid-ask spread. We derive the maximizer for the insider's revenue function and prove sufficient conditions for an equilibrium in the game. Then, we use neural networks methods to verify that this equilibrium holds. We show that the equilibrium state in this model experience interesting phase transitions, as the weight of the revenue term in the market maker's performance function changes. Specifically, the asset price in equilibrium experience three different phases: a linear pricing rule without a spread, a pricing rule that includes a linear mid-price and a bid-ask spread, and a metastable state with a zero mid-price and a large spread.

SPACs and Forward-Looking Disclosure: Hype or Information?

Regulators and legal scholars express concern that SPAC growth results from a disclosure-regulation loophole and that forward-looking disclosure by SPACs can mislead investors. We examine SPAC voluntary disclosure and associated outcomes. SPACs offer a means for firms to become public, but, unlike IPOs, we find SPAC firms frequently provide forward-looking information (e.g., earnings forecasts). Measuring disclosure by tone, the existence of a forecast, forecasting intensity, and forecast growth rates, our results suggest that forward-looking disclosure in SPAC merger announcements does not mislead small investors. Disclosures containing more forecasts are associated with positive returns at the announcement. However, our disclosure measures are not associated with subsequent return reversals. More forecasts are related to positive subsequent return drift, lower redemption rates and bid-ask spreads, and more retail investor buying. We do not find evidence that forecasted sales or EBITDA growth rates are associated with return reversals. In fact, we find a positive relation between forecasted sales growth and returns around the first post-closing earnings announcement. Moreover, correlations between outcomes and disclosure tone are not significant, suggesting that hype, if present, does not sway investors. Our findings do not support the concern that SPACs take advantage of apparent exemption from prosecution under the 1933 Act to hype forward-looking disclosure to deceive shareholders.