Components of the Bid-Ask Spread and Variance: A Unified Approach
2016 (English)In: Journal of futures markets, ISSN 0270-7314, E-ISSN 1096-9934, Vol. 36, no 6, 545-563 p.Article in journal (Refereed) Published
We develop a structural model for the price formation and liquidity supply of an asset. Ourmodel facilitates decompositions of both the bid–ask spread and the return variance intocomponents related to adverse selection, inventory, and order processing costs. Furthermore,the model shows how the fragmentation of trading volume across trading venues inﬂuencesinventory pressure and price discovery. We use the model to analyze intraday price formationfor gold futures traded at the Shanghai Futures Exchange. We ﬁnd that order processing costsexplain about 50% of the futures bid–ask spread, whereas the remaining 50% is equally due toasymmetric information and to inventory costs. About a third of the variance in futures returnsis attributable to microstructure noise. Trading at the spot market has a signiﬁcant inﬂuence onfutures price discovery, but only a limited impact on the futures bid–ask spread.
Place, publisher, year, edition, pages
2016. Vol. 36, no 6, 545-563 p.
Research subject Business Administration
IdentifiersURN: urn:nbn:se:su:diva-129943DOI: 10.1002/fut.21776ISI: 000375465200003OAI: oai:DiVA.org:su-129943DiVA: diva2:926063
FunderThe Jan Wallander and Tom Hedelius Foundation