Order Processing Cost Components Research Articles

Analysis of ETF bid-ask spread components

Abstract In this study we examine on intradaily basis (milliseconds) the largest 100 ETFs’ bid-ask spread components in the period March 21, 2014 to April 17, 2014. We document that ETFs have lower proportion of adverse selection in the bid-ask spread relative to stocks, which also means that the order processing cost component is higher in ETFs. This suggests that uninformed investors prefer to trade ETFs relative to individual stocks. The data in our study also suggests a U-shaped form of the adverse selection component across four categories of ETF trading volume and not a monotone decreasing relation from lowest to highest trading volume ETFs. Fixed-income ETFs have the highest adverse selection component coefficient whereas real estate ETFs have the lowest. Additionally, mutual fund structured ETFs have lower adverse selection component coefficient than the trust structured ETFs. We also document that ETFs with more quotes have lower adverse selection; whereas ETFs with higher average bid price, higher expense ratio and trust structuring of the ETF have higher adverse selection component of the bid-ask spread.

Earnings announcements and the components of the bid‐ask spread

PurposeThe purpose of this paper is to investigate the impact of the components of the bid‐ask spread around earnings announcements on the London Stock Exchange using intraday data obtained from the ICV Marketeye database. The paper finds that the information asymmetry cost component significantly increases around the earnings announcements, while the inventory holding and order processing cost components significantly decrease around the same period. Specifically, the economic magnitude of the increase in the asymmetric cost component implies that earnings announcements significantly increase the total bid‐ask spread, even when they result in decreased inventory holding and order processing costs.Design/methodology/approachLiquidity in financial markets around earnings announcements in the London Stock Exchange obtained by bid‐ask spread decompositions.FindingsThis paper investigates the impact of earnings announcements on the components of the bid‐ask spread on the London Stock Exchange using intraday data. The fundamental conclusion from the empirical findings is that the bid‐ask spread increases once the earnings have been announced, because the market makers' increased concerns about asymmetric information is more pronounced, than the lower inventory and order processing costs due to the higher levels of trading volume. This empirical finding also holds when the earnings announcements are partitioned into positive and negative surprises.Originality/valueThis is the first paper to decompose the bid‐ask spread around earnings announcements on the London Stock Exchange. The paper uses a unique intraday dataset.

Adverse selection costs: A study on the Chinese stock market

Employing a bid-ask spread model applicable for order-driven market, this paper decomposes the bid-ask spread of Shanghai Stock Exchange (SSE) into adverse selection and order processing cost components to investigate the relationship between the components of bid-ask spread and order size. It examines the impacts of firm size, price, trading activeness, and volatility on adverse selection cost, and explores the intraday pattern of adverse selection costs and informative trading. Results show that adverse selection costs increase with trade scale. However, order processing costs do not exhibit the economies of scale. Stocks of large firms, which are high-priced and actively traded, have relatively low adverse selection costs; stocks with large volatility have relatively high adverse selection costs. Moreover, this paper finds that the adverse selection component of bid-ask spread in the Chinese stock market exhibits an L-shaped intraday pattern, which implies that heavy trading around market opening is dominated by informative trading, while heavy trading near market closing is dominated by liquidity trading.

Inventory management effects, isolated: Evidence from the federal funds market

Abstract The federal funds market is highly competitive, has uniform information, and does not have most order-processing cost components of equity markets. Hence, it provides an opportunity to study the effect of inventory management on the bid-ask spread in an isolated fashion. Using a unique data set of daily borrowing and lending federal funds quotes posted by a large commercial bank, we find that the bank maintains a fairly constant bid-ask spread throughout a two-week reserve maintenance period. It acts similarly to a market maker facilitating flow of funds between depository institutions throughout the reserve maintenance period. The bank becomes more active toward the end of the period. In particular, on settlement Wednesday it increases the bid and ask quotes relative to the effective federal funds rate in an apparent attempt to manage its reserve inventory and satisfy its own reserve requirements.

The components of bid‐ask spread and their determinants: TAIFEX versus SGX‐DT

AbstractThis paper compares the intraday components of bid‐ask spread in Taiwan stock index futures traded on Taiwan Futures Exchange (TAIFEX) and Singapore Exchange Derivatives Trading Limited (SGX‐DT). Variables that determine the components of spread are also examined. SGX‐DT uses a floor trading system while TAIFEX uses an electronic call system. This study finds that both information asymmetry and order processing cost components exhibit U‐shaped patterns in the two markets, in contrast to previous findings for U.S. equity markets. Moreover, the information asymmetry components are lower in the TAIFEX relative to the SGX‐DT futures, suggesting that the continuous open outcry markets are more vulnerable to information asymmetry than the electronic call markets. The regression results show that volatility and information are the major determinants of the components while number of trades is not the major determinant of the order processing and information asymmetry components for both markets. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:835–860, 2004

Margin regulation and market quality: a microstructure analysis

We find that trading volume increases and market liquidity remains unchanged, while the adverse selection and order-processing cost components of the spread increase and decrease, respectively, after margin levels decline when stocks become margin-eligible. This evidence indicates that the information content of trades has increased, thereby improving market quality. However, no changes were detected after the 1997 regulatory reforms. These results have implications across a broad swath of corporate finance dimensions, including the (1) cost of capital, (2) public vs. private financing decision, (3) form of managerial compensation, (4) type of ownership structure, and (5) degree of shareholder monitoring.

Asymmetric information and the bid-ask spread: an empirical comparison between automated order execution and open outcry auction

This study examines the components of the bid-ask spread on the Sydney Futures Exchange. The Exchange uses open outcry auction for daytime trading, and switches to a screen-based automated order execution system at 16:30 h for overnight trading. After controlling for proxies of order flow characteristics, the study finds that screen-based traders are more sensitive to market volatility than floor-based traders in setting the bid-ask spread. Spreads from floor trading have a smaller adverse information component but a larger order processing cost component relative to screen trading. The results suggest that floor traders can better assess the presence of adverse information than screen traders.

Determinants of the components of bid‐ask spreads on stocks

AbstractIn this paper we show that George et al. (GKN, 1991) estimators of the adverse selection and order processing cost components of the bid‐ask spread are biased due to intertemporal variations in the bid‐ask spread. We use alternative estimators that correct this bias and that are applicable to individual securities, and estimate these cost components empirically using data on NYSE/AMEX stocks. As expected, our results indicate that on average adverse selection costs account for approximately 50% of the bid‐ask spread, sharply higher than the estimates of 8‐10% obtained by GKN for NASDAQ stocks and 21% that we obtain for NYSE/AMEX stocks using GKN's estimators. We then conduct cross‐sectional regressions designed primarily to determine whether adverse selection costs vary across specialists after controlling for firm size and other factors. Consistent with previously established hypotheses, we find that adverse‐selection costs vary across specialists, and that this variation is related to the number of securities that the specialist handles.

Trade Size and Components of the Bid-Ask Spread

The relation between theorized components of the bid-ask spread and trade size for a sample of NYSE firms is examined. We find that the adverse selection component increases uniformly with trade size. Conversely, order processing costs decrease with increases in trade size for all but the largest trades. We find that order persistence decreases with trade size. The adverse selection component is highest at the beginning of the day and lowest at the end of the day for all but the largest trades. Trades of NYSE firms executed on regional exchanges or NASDAQ contain a large order processing cost component but no significant adverse information effect. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Order Flow, Trading Costs and Corporate Acquisition Announcements

The bid-ask spread is an important element of investors' transactions costs. Theoretical papers decompose the spread into adverse selection, inventory cost, and order processing cost components. The order processing cost component compensates the stock exchange specialist for providing immediacy to buyers and sellers. The inventory cost component compensates the specialist for the risk of holding an inventory of a stock. The inventory component is larger for high-priced stocks, stocks which trade infrequently, and stocks with a relatively uncertain value. This study focuses on the adverse selection component of the spread, which compensates the specialist for losses to traders who have inside information. Prior theoretical work suggests that the adverse selection component will be larger, the greater the proportion of traders who have private information. The specialist will widen the spread in response to a perceived increase in the probability that the next trader is privately informed. Prior studies also suggest that privately informed traders will generally trade larger amounts than uninformed traders. Consequently, trade size should impart information about the probability that a trader is privately informed.