Dollar Spreads Research Articles

Option Bid-Ask Spread and Liquidity

This paper focuses on the search for a summary quantitative measure for option liquidity that is economically meaningful and easy to implement. We show that the relative spread measure (quoted dollar bid-ask spread relative to the mid-quote price) not only leads to liquidity ranking of options that is contrary to the popular view, but it is also biased against lower priced options and hence can lead to erroneous conclusion about liquidity risk premium of options. To gain economic insight in this regard, we use a simple inventory hedging model of bid-ask spread.We propose two alternative summary measures of option liquidity, one using the option implied dollar volatility of the asset to scale the dollar spread and the other expressing the bid, ask and mid-quote option prices in terms of respective implied volatilities. Using a sample of more than two million end of day option quotes for thirty Dow Jones stocks and Goldman Sachs, we find that these very simple and intuitive measures seem to produce liquidity ranking of options that is generally consistent with common knowledge about options liquidity.

Hedge funds as international liquidity providers: evidence from convertible bond arbitrage in Canada

We examine the impact of Canadian convertible bond issuance on equity market liquidity. Using issuance event dates between April 2002 and March 2011, we analyze the change in short interest and stock liquidity during a 1-year event window. We consider mainstream liquidity measures, including turnover, dollar volume, dollar spread, percentage spread, and the ratio of daily absolute stock return to dollar volume. We find that after convertible bond issuances, there are significant increases in short interest, but minimal overall improvements in liquidity. The change in liquidity is not significantly related to the change in short interest, except for the firms with large change in short interest. Interpreting increased short interest after issuance as a proxy for convertible bond arbitrage activity, the results suggest that there is limited positive liquidity externality of hedge fund activity in Canada.

Investigating the Price Dynamics between Europe ETFs: EZU vs FEZ

This paper studies the behavior of two Exchange Traded Funds, namely, EZU & FEZ and investigates the price dynamics to develop a trading strategy for them. Dollar spread between the two ETFs is examined to develop a stochastic model for the process and consequently to find the optimal threshold for technical trading indicators. Modelling the dollar spread by a trend-line approach, we use a special case of simple linear regression model in which the independent variable is a time index variable to find the upper/lower bands. We use moving average as an exit indicator, where we go long at our lower band and close it at the moving average, then we go short at our upper band and then buy at the moving average. We test our strategy for different moving averages and note down the trading statistics.

Option Bid–Ask Spread and Liquidity

This article focuses on the search for a economically meaningful and easy to implement summary quantitative measure for option liquidity. The author shows that the relative spread measure (quoted dollar bid–ask spread relative to the midquote price) not only leads to liquidity ranking of options that is contrary to the popular view, but it is also biased against lower-priced options and hence can lead to erroneous conclusion about the liquidity risk premium of options. To gain economic insight in this regard, he uses a simple inventory hedging model of bid–ask spreads. He proposes two alternative summary measures of option liquidity: one using the implied dollar volatility of the asset to scale the dollar spread and the other expressing the bid, ask, and midquote option prices in terms of respective implied volatilities. Using a sample of more than two million end-of-day option quotes for 30 Dow Jones stocks and Goldman Sachs, the author finds that these very simple and intuitive measures seem to produce a liquidity ranking of options that is generally consistent with common knowledge about options liquidity.

Hedge Funds as International Liquidity Providers: Evidence from Convertible Bond Arbitrage in Canada

We examine the impact of Canadian convertible bond issuance on equity market liquidity. Using issuance event dates between April 2002 and March 2011, we analyze the change in short interest and stock liquidity during a 1-year event window. We consider mainstream liquidity measures, including turnover, dollar volume, dollar spread, percentage spread, and the ratio of daily absolute stock return to dollar volume. We find that after convertible bond issuances, there are significant increases in short interest, but minimal overall improvements in liquidity. The change in liquidity is not significantly related to the change in short interest, except for the firms with large change in short interest. Interpreting increased short interest after issuance as a proxy for convertible bond arbitrage activity, the results suggest that there is limited positive liquidity externality of hedge fund activity in Canada.

Impacts of stock splits on transaction costs under different tick size regimes

This study determines the impacts of stock splits on transaction costs under tick sizes of $1/16 and $0.01. Similar to previous studies, stock splits decrease quoted dollar spreads and effective dollar spreads, and they increase quoted percentage spreads and effective percentage spreads. The effect of stock splits, however, differs depending on tick size. Quoted percentage spreads increase 44% with the smaller tick size ($0.01), but increase 56% with the larger tick size ($1/16). Moreover, effective percentage spreads increase 39% with the smaller tick size, but increase 44% with the larger tick size. In addition, under the $1/16 tick size regime stock splits increase quoted depth, but under the $0.01 tick size regime stock splits decrease quoted depth.

Determinants of Volume in Dark Pools

I investigate determinants of trading volume for NASDAQ stocks in the two largest “dark pools” that cater to large institutional trades: Liquidnet and POSIT. I find that these dark pools capture a lower faction of institutional volume for stocks with higher levels of adverse selection, which is consistent with the prediction from Zhu (2013), but inconsistent with the prediction from Ye (2011). Orders in stocks with higher percentage spreads are less likely to be routed to these dark pools, which is consistent with the predictions from Zhu (2013) and Buti et al (2011a) but inconsistent with the predictions from Hendershott and Mendelson (2000) and Degryse et al. (2009). I also show that usage of these dark pools is lower for stocks with the lowest dollar spreads per share, which is consistent with trader routing of these stocks to other venues in order to satisfy soft-dollar agreements.

Analysis of the Tick Size and the Impact of Varying Dollar Ticks on Market Quality – Evidence from the Sydney Futures Exchange

This paper investigates the relationship between the minimum price variation and market quality variables for 3 interest rate futures contracts on the Sydney Futures Exchange. Intraday trade and quote data are obtained for the period 4 January 2000 and 1 February 2002, which includes the change in transparency on 19 January 2001. Analysis of the frequency distributions of bid and ask quote variations show a high frequency of these variations posted at 1 tick in the sample periods. Analysis of the quoted bid-ask spreads also show a high frequency of spreads posted at 1 tick. These evidence suggest that the tick sizes for these futures contracts are too large. Examination of the relationships between dollar spreads and dollar ticks provide further evidence that dollar spreads are constrained by the tick size. Dollar spreads are found to be positively related to dollar ticks, average quoted depth and trade price volatility, and negatively related to traded volume. This journal article is available in Australasian Accounting, Business and Finance Journal: http://ro.uow.edu.au/aabfj/vol1/iss4/2 The Australasian Accounting Business & Finance Journal, December, 2007. Tan, Frino and Jarnecic: Analysis of Tick Size. Vol. 1, No. 4. Page 16. Analysis of the Tick Size and the Impact of Varying Dollar Ticks on Market Quality – Evidence from the Sydney Futures Exchange

Modeling Credit Risk

Spreads for credit instruments denominated in euros, sterling, and U.S. dollars over their local swap curves are examined here. The findings indicate that monthly spread changes were strongly currency-dependent during the period May 1999–May 2001. Sector-by-rating factor returns are at best weakly correlated across currencies, and U.S. dollar spread returns are generally more volatile than the other two by a factor of two or three. This is contrary to what would be expected from covered interest arbitrage. The conclusion is that analysts should estimate credit factor risk models separately in each market, as risk forecasting models using a single set of spread factors for different markets will not be accurate.

Large price movements and short-lived changes in spreads, volume, and selling pressure

In this paper we examine changes in dollar and relative bid-ask spreads of stocks following large price movements. We investigate large increases and decreases separately and link our results to current market microstructure theories on trading activities and spreads. We also look at changes in volume and selling pressure to interpret the changes in trading activity. Our results show that the market reacts differently to price increases and decreases. For large price decreases, trading increases on the sell side even when spreads have increased. For large price increases, trading increases on the buy side during a period of higher spreads. However, the increases in dollar spreads and price pressure are most pronounced at the end of trading day. Our results are consistent with microstructure models that link trading activities and costs to the level of asymmetric information.

The Information Content of Dividend Initiations and Firm Size: An Analysis Using Bid‐Ask Spreads

AbstractThe bid‐ask spread of stock prices is examined for a sample of dividend initiating firms. The average percentage and dollar bid‐ask spreads increase significantly on the day preceding the Wall Street Journal Index announcement date, possibly reflecting, on average, the market maker's anticipatory uncertainty. The day ‐1 increase in spread is inversely associated with firm size, an information environment proxy, after considering the simultaneous effects of dividend yield, returns variance, dollar trading volume and share price. The average percentage spread declines significantly on day 0 from its day ‐1 level and remains lower, on average, over a 365 day post‐announcement period than 90 day pre‐announcement levels. Similar results are obtained for dollar spread averages. The post‐announcement percentage spread decline suggests a resolution of uncertainty, and is positively associated with the dividend yield. Dividend initiation announcements appear to reduce informational asymmetry.

Market Structures and Liquidity: A Transactions Data Study of Exchange Listings

This paper examines the change in trading costs for firms that choose to move from a dealer market to a specialist system. Using transactions data, our empirical results reveal structurally induced average trading cost reductions of 4.7 (5.2) cents per share for firms that moved from the NASDAQ/NMS to the NYSE (AMEX) in 1990. For NYSE listed stocks, the trading cost reductions are equally divided between quote improvements and the routing of trades to the NYSE. Trading cost improvements vary inversely with trade sizes and positively with dollar spreads. Finally, the greatest liquidity benefits from listing accrue to the less liquid stocks. Journal of Economic Literature Classification Numbers: D40, G12, G20.

Option Introduction and Liquidity Changes in the OTC/NASDAQ Equity Market

This paper examines the impact of option listing in the NASDAQ equity market on the bid-ask spread of the underlying stock. We find that both the market adjusted percentage and dollar spreads decrease with option listing, which is consistent with a value enhancing impact of derivative security introduction.

An Alternative to Uniform Expenditure Reductions in Multiple Resource State Finance Programs

The purpose of this study was to demonstrate an alternative procedure for reducing state expenditures in ongoing state programs without resulting in the major description commonly associated with uniform or across-the-board state budget cuts. Using, for purposes of illustration only, a problem involving the reduction in state expenditures for a school finance program, a linear programming model was derived—then applied. The purpose or objective of the model was to determine the required state resource allocation strategy which would minimize the state's financial commitment (however it may be defined by educators and legislators) without seriously affecting the financial support for educational expenditures at the school district level. In the state finance program studied, the total state expenditure could have been reduced by over one million dollars with no reduction in the state guaranteed minimum level of expenditure (referred to as the foundation level) per ADA (student in average daily attendance). Peripheral benefits such as a large amount of property tax relief, more state aid to districts with a poor tax base, and a decrease in the dollar spread in per pupil expenditures between districts were also achieved. The results of the study indicate possibilities for utilizing linear programming or similar methods for other state resource allocation problems involving revenues from federal, state or local sources.

ACHIEVING PROPERTY TAX RELIEF WITH A MINIMUM DISRUPTION OF STATE PROGRAMS

The purpose of this paper is to propose a rational and systematic procedure for achieving property tax relief with minimum disruption in ongoing state programs. A pilot study was performed which applied linear programming techniques to an educational finance program to determine if property tax relief could be achieved with minimum disruption in state financial assistance to local school districts. The results obtained from applying the model to a junior college state support program indicate that with the same commitment in state funds, over two and one-half million dollars of property tax relief could be realized with no reduction in the state guaranteed minimum level of expenditure per ADA, commonly known as the foundation level. The foundation level, according to state mandate, represents the minimum school district expenditure required to insure an instructional program of adequate educational quality. In addition to maintaining the present foundation level, certain peripheral benefits associated with decreasing the dollar spreads in per pupil expenditures between school districts were also obtained by use of this technique. This latter benefit might be related to insuring financial equality of educational opportunity for all students in the state regardless of the local wealth of the school district.