Inside Spread Research Articles

Order Aggressiveness and Order Book Dynamics

In this paper, we study the determinants of order aggressiveness and traders' order submission strategy in an open limit order book market. Using order book data from the Australian Stock Exchange, we model traders' aggressiveness in market trading, limit order trading as well as in order cancellations on both sides of the market using a six-dimensional autoregressive intensity model. The information revealed by the open order book plays an important role in explaining the degree of order aggressiveness in the individual processes. Moreover, evidence for significant dynamic interdependencies between the individual processes confirms the usefulness of the multivariate setting. Overall, our empirical results confirm theoretical findings on limit order book trading and show that a trader's decision of when and which order to submit is significantly influenced by the queued volume, the market depth, the inside spread, recent volatility, as well as recent changes in both the order flow and the price.

Daily Closing Inside Spreads and Trading Volumes Around Earnings Announcements

This paper examines the determinants of inside spreads and their behaviour around corporate earning announcement dates, for a sample of UK firms over the period 1986–94. The paper finds that closing daily inside spreads are affected by order processing costs (proxied by trading volumes), inventory control costs (trading volumes and return variability) and asymmetric information (unusually high trading volumes). Inside spreads start to narrow 15 days before an earnings announcement, and narrow further by the end of the announcement day. We also identify a puzzling phenomenon. There is only a ‘sluggish’ recovery of spreads after the announcement: inside spreads continue to remain at relatively narrow levels, and take up to 90 days to recover to their pre–announcement width.

Limit vs. Market Order Trading on the Saudi Stock Market

This paper uses an order data set to analyze trading by limit versus market orders on the Saudi Stock Market. Building on the literature on a trader's choice problem in order driven markets, we interpret the data using a Random Utility Model and approach the problem statistically using a logit model. The performance of the orders resulting from the decisions of traders also is examined. The empirical results show that the probability of placing a market order is negatively related to the inside spread and order size, and is positively related to order imbalance and previous same-side market orders. The performance measures indicate that limit order strategies perform better than a market order strategy.

Liquidity Beyond the Inside Spread: Measuring and Using Information in the Limit Order Book

World equity markets increasingly convert to electronic trading, in many cases adopting the format of a pure electronic order book without intermediaries. A distinguishing feature of this format is that a high proportion of available liquidity is committed (displayed) rather than implicit or hidden. We examine the properties of a measure of liquidity, the Cost of Round Trip trade (CRT), which aggregates the status of the limit order book at any moment in time for a specific transaction size. CRT, which measures the ex ante committed liquidity immediately available in the market, complements the effective spread, which measures the ex post combination of the committed and hidden liquidity available over a period of time. We use data from the Toronto Stock Exchange to compare CRT to the quoted and effective spreads, and estimate its ability to predict the subsequent trading activity. While we propose CRT as a research tool, we also advocate its use by exchanges to indicate to investors the level of committed liquidity.

Variance Component Analysis and Heritability of Antler Traits in White-Tailed Deer

Information on genetic and environmental sources of variation that control antler development in white-tailed deer (Odocoileus virginianus) is needed to develop harvest management programs. We estimated genetic and environmental components of variance for antler development traits collected from deer born from 1977 to 1993 in a captive population. Antler traits were incidence of spikes versus forks, number of points, maximum inside spread, total mass, main beam circumference, and main beam length. In 1.5-year-old males, the degree of additive genetic determination, or heritability (h 2 ), was low (range = 0.00-0.13) for incidence of spikes versus forks, number of points, maximum inside spread, total mass, and main beam length, and was moderate for main beam circumference (h 2 = 0.25). The relatively large carryover influence of the dam as a source of variation was more important than heritability. In 2.5-year-old males, antler-trait heritabilities were low to moderate (0.08-0.39), whereas heritability ranged from 0.03 to 0.43 in mature males (3.5-7.5 years old) with repeated antler-trait records. Permanent and residual effects caused by nonadditive genetic and environmental factors accounted for most of the variation in antler traits expressed by mature males. Our results do not support the use of yearling antler records as criteria for selective breeding management or harvest schemes to alter the genetic quality of a white-tailed deer population.

Preferencing, Internalization, Best Execution and Dealer Profits

The practices of preferencing, internalization, and best execution have been criticized as causing worse execution in dealership markets like NASDAQ relative to auction style markets like the NYSE. We study the quality of executions and the profitability of market making for internalized, preferenced and non-preferenced order flow on the London Stock Exchange for the FTSE-100 stocks (these are the most liquid stocks on the exchange). Our data allow us to identify the broker who initiates and the market maker who executes each trade. Our results indicate that order flow executed by market makers not posting the best quotes (preferenced order flow) receives worse execution relative to non-preferenced order flow while the order flow routed by a broker to a dealer belonging to the same firm (internalized order flow) receives better execution compared to the rest of the order flow. Although preferenced order flow is associated with higher spreads, dealers executing a larger proportion of preferenced order flow do not seem to be make significantly higher trading profits. In addition, we find that the dealers make overall profits that are not statistically different from zero. These results are contrary to the predictions of the `collusion' hypothesis and the `quotes are free options' hypothesis. However, they are consistent with the hypothesis that there are costs of negotiating quotes and that customers have relationships with dealers. We also find evidence that dealers make money on small and large trades but lose money on medium sized trades which is consistent with the `stealth trading' hypothesis. Finally, cross-sectionally in our sample, we do not find any relationship between either the inside spread or the effective spread in a stock and the extent of preferencing or internalization in that stock.

Cost of Transacting and Expected Returns in the Nasdaq Market

ABSTRACTThis article empirically examines the liquidity premium predicted by the Amihud and Mendelson (1986) model using Nasdaq data over the 1973–1990 period. The results support the model and are much stronger than for the New York Stock Exchange (NYSE), as reported by Chen and Kan (1989) and Eleswarapu and Reinganum (1993). I conjecture that the stronger evidence on the Nasdaq is due to the dealers' inside spreads on the Nasdaq being a better proxy for the actual cost of transacting than the quoted spreads on the NYSE, since the Nasdaq dealers do not face competition from limit orders or floor traders.

Entry, Exit, Market Makers, and the Bid-Ask Spread

The probability of entry and exit of dealers on the NASDAQ National Market (NNM) is significantly affected by trading intensity, volatility and the quoted bid-ask spread. Entry and exit of market makers is a pervasive phenomenon. Large-scale entry (exit) is associated with substantial declines (increases) in quoted end-of-day inside spreads, even after controlling for the effects of changes in volume and volatility. The spread changes are larger in magnitude for issues with few market makers; however, even for issues with a large number of market makers, substantial changes in quoted spreads take place. The results are consistent with the competitive model of dealer pricing.

Bid‐ask Spreads, Trading Volume and Volatility: Intra‐day Evidence from the London Stock Exchange

This paper examines intra‐day variations in the bid‐ask spread, volatility and volume for stocks traded on the London Stock Exchange. The data set used consists of quote and transactions data for a large sample of 835 stocks traded during the first quarter of 1991. The focus of the study is twofold; first, is to document a number of stylized facts regarding the intra‐day behaviour of spread, trading volume, volatility etc. Second, the paper tests some predictions of two theoretical models of intra‐day behaviour: the Admati and Pfleiderer and the Brock and Kleidon models. In addition, the paper also studies qualitatively the intra‐day behaviour of several variables of interest including volume per transaction, transactions per fifteen‐minute interval and spreads/trading volume for stocks of differing liquidity. The results suggest that the bid‐ask spread is wide at the open, constant through the day and rises slightly at the close. Trading volume, in contrast is not highest at the open and the close. Volatility, based on the mid‐point of the inside spread, shows a U‐shaped pattern. Volume per transaction, in contrast, is fairly constant throughout the day. Further, the intra‐day trading volume pattern differs for liquid and illiquid stocks. The results provide mixed support for current theoretical models of intra‐day behaviour of spread, volume and volatility on the London Stock Exchange

THE DETERMINANTS AND DYNAMICS OF BID‐ASK SPREADS ON THE LONDON STOCK EXCHANGE

AbstractWe analyze the effect of various factors on the size of spreads on the London Stock Exchange since “Big Bang” and find that the price of a security, volume of transactions, risk associated with security returns, and degree of competition among market makers explain 91 percent of the cross‐sectional variation in spreads. The results are consistent with the argument that the inside spread encompasses the order‐processing, inventory‐adjustment, and adverse‐information cost of spreads. We also investigate the speed at which spreads move toward their normal levels after a temporary deviation. Although the speed of adjustment varies across firms, the cross‐sectional median of 0.896 indicates it takes more than one period (day) for the adjustment to be completed. The volume of transactions and the degree of competition among market makers are the significant factors that affect the speed of correction in spreads toward their normal levels. This implies private information is incorporated more quickly into prices for stocks with greater competition and high trading volume.

Why do NASDAQ Market Makers Avoid Odd‐Eighth Quotes?

ABSTRACTThe NASDAQ multiple dealer market is designed to produce narrow bid‐ask spreads through the competition for order flow among individual dealers. However, we find that odd‐eighth quotes are virtually nonexistent for 70 of 100 actively traded NASDAQ securities, including Apple Computer and Lotus Development. The lack of odd‐eighth quotes cannot be explained by the negotiation hypothesis of Harris (1991), trading activity, or other variables thought to impact spreads. This result implies that the inside spread for a large number of NASDAQ stocks is at least $0.25 and raises the question of whether NASDAQ dealers implicitly collude to maintain wide spreads.

Why do NASDAQ Market Makers Avoid Odd-Eighth Quotes?

The NASDAQ multiple dealer market is designed to produce narrow bid-ask spreads through the competition for order flow among individual dealers. However, we find that odd-eighth quotes are virtually nonexistent for 70 of 100 actively traded NASDAQ securities, including Apple Computer and Lotus Development. The lack of odd-eighth quotes cannot be explained by the negotiation hypothesis of Harris (1991), trading activity, or other variables thought to impact spreads. This result implies that the inside spread for a large number of NASDAQ stocks is at least $0.25 and raises the question of whether NASDAQ dealers implicitly collude to maintain wide spreads.

Confrontation in Southern Africa: Zambia and Portugal

The roots of the present conflict between Zambia and Portugal are to be found in the determination of the Portuguese to perpetuate their harsh colonial rule in Angola and Mozambique and in the refusal of Zambians to tolerate its continuance indefinitely. Zambia's external interests and concerns have traditionally been oriented towards the south, but in recent years it has been compelled to pay increased attention to its neighbours to the east and west. In the process of disengaging from dependence on outlets to the sea through Rhodesia, it has come to rely heavily on the Malawi railway to Beira in Mozambique and especially on the Benguela Railway to Lobito in Angola. Moreover, as disillusionment with developments in Rhodesia and South Africa has deepened, Portuguese Africa has seemed to offer the liberation movement not only relatively greater prospects of success but also the best hope of an opening into the southern African laager. Zambia has, in fact, found itself very much in the front line in the nationalist struggles against the Portuguese. In 1966 fighting inside Angola spread to Zambia's western boundary and also erupted in the Tete district of Mozambique on its eastern boundary. The mounting scale of Portuguese military operations in these areas resulted in a series of border incidents and clashes as well as the influx into Zambia of thousands of Angolan and Mozambique refugees. Admittedly, Zambia is not alone in facing the Portuguese. Tanzania borders Mozambique and the Congo (Kinshasa) Angola, but Zambia is unique in sharing a common frontier with both Portuguese colonies -for a distance totalling a thousand miles. In addition, landlocked Zambia is more vulnerable than either Tanzania or the Congo to Portuguese economic and military pressure, weapons that Lisbon is not reluctant to exploit.