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Rev Fin 1997; 10:995-1034
© 1997 the Society for Financial Studies

Article

The components of the bid-ask spread: a general approach

RD Huangz and HR Stoll
Owen Graduate School of Management, Vanderbilt University, Nashville, TN 37203, USA
z Corresponding author

Abstract

A simple time-series market microstructure model is constructed within which existing models of spread components are reconciled. We show that existing models fail to decompose the spread into all its components. Two alternative extensions of the simple model are developed to identify all the components of the spread and to estimate the spread at which trades occur. The empirical results support the presence of a large order processing component and smaller, albeit significant, adverse selection and inventory components. The spread components differ significantly according to trade size and are also sensitive to assumptions about the relation between orders and trades.


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