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- Title
Revisiting the Bid-Ask Spread via Competitive Search.
- Authors
Garrison Hongyu Song; Chung Chen
- Abstract
In this paper, we set up a competitive search model to re-interpret the existence of the market equilibrium bid-ask spread in a stylized security market, in which market dealers are in charge of posting an instantaneous bid price while investors choose whether to sell their share or not at this price. Different from the conventional asymmetric information based explanations, our search based model emphasizes that since the market dealers provide necessary liquidity to the security market via playing such an intermediary role between actual buyers and sellers, the bid-ask spread charged thereafter should largely be justified as the compensation for the market dealers' endeavor in this process. Our model provides a closed-form bid-ask spread formula which has a capacity to reproduce many empirical observations with respect to the effects of the market dealers' maintenance cost, the dividends payoff etc. on the bid-ask spread. Our model further indicates that the absolute bid-ask spread(in dollars) is positively related to the stock price level while the relative bidask spread (in percentage) is negatively related to the stock price level, which well solves the puzzle of the impact of stock splits on stock liquidity without the assumption of asymmetric information.
- Subjects
SPREAD (Finance); MICROSTRUCTURE; MARKET equilibrium; INFORMATION asymmetry; LIQUIDITY (Economics)
- Publication
Banking & Finance Review, 2016, Vol 8, Issue 1, p111
- ISSN
1947-7945
- Publication type
Article